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UPDATE: To Buy, Or Not To Buy- An Investors Guide to QE 4

In our RIA Pro article, To Buy, Or Not To Buy- An Investors Guide To QE4, we studied asset performance returns during the first three episodes of QE. We then normalized the data for the duration and amount of QE to project how QE4 might affect various assets.  

With a month of QE4 under our belt, we update you on the pacing of this latest version of extreme monetary policy and review how various assets are performing versus our projections. Further, we share some recent comments from Fed speakers and analyze trading in the Fed Funds market to provide some unique thoughts about the future of QE4.

QE4

Since October 14th, when QE4 was announced by Fed Chairman Jerome Powell, the Fed’s balance sheet has increased by approximately $100 billion. The graph below compares the current weekly balance sheet growth with the initial growth that occurred during the three prior iterations of QE.  

Data Courtesy St. Louis Federal Reserve

As shown above, the Fed is supplying liquidity at a pace greater than QE2 but slightly off the pace of QE 1 and 3. What is not shown is the $190 billion of growth in the Fed’s balance sheet that occurred in the weeks before announcing QE4. When this amount is considered along with the amount shown since October 14th, the current pacing is much larger than the other three instances of QE.

To put this in context, take a step back and consider the circumstances under which QE1 occurred. When the Fed initiated QE1 in November of 2008, markets were plummeting, major financial institutions had already failed with many others on the brink, and the domestic and global economy was broadly in recession. The Fed was trying to stop the worst financial crisis since the Great Depression from worsening.

Today, U.S. equity markets sit at all-time highs, the economic expansion has extended to an all-time record 126 months, unemployment at 3.6% is at levels not seen since the 1960s, and banks are posting record profits.

The introduction of QE4 against this backdrop reveals the possibility that one of two things is occurring, or quite possibly both.

One, there could be or could have been a major bank struggling to borrow or in financial trouble. The Fed, via repo operations and QE, may be providing liquidity either to the institution directly or indirectly via other banks to forestall the ramifications of a potential banking related default.

Two, the markets are struggling to absorb the massive amount of Treasury debt issued since July when Congress extended the debt cap. From August through October 2019, the amount of Treasury debt outstanding grew by $1 trillion. Importantly, foreign entities are now net sellers of Treasury debt, which is worsening the problem. For more read our recent article, Who Is Funding Uncle Sam?

The bottom line is that the Fed has taken massive steps over the last few months to provide liquidity to the financial markets. As we saw in prior QEs, this liquidity distorts financial markets.  

QE4 Projections and Updates

The following table provides the original return projections by asset class as well as performance returns since October 14th.  The rankings are based on projected performance by asset class and total.  

Here are a few takeaways about performance during QE4 thus far:

  • Value is outperforming growth by 1.67% (5.95% vs. 4.28%)
  • There is general uniformity amongst the equity indexes
  • Equity indices have captured at least 50%, and in the case of value and large caps (S&P 100) over 100% of the expected gains, despite being only one-sixth of the way through QE4
  • The sharp variation in sector returns is contradictory to the relatively consistent returns at the index level
  • Discretionary stocks are trading poorly when compared to other sectors and to the expected performance forecast for discretionary stocks
  • Defensive sectors are trading relatively weaker as occurred during prior QE
  • The healthcare sector has been the best performing sector within the S&P as well as versus every index and commodity in the tables
  • The yield curve steepened as expected
  • In the commodity sector, precious metals are weaker, but oil and copper are positive

Are Adjustments to QE4 Coming?

The Fed has recently made public statements that lead us to believe they are concerned with rising debt levels. In particular, a few Fed speakers have noted the sharp rise in corporate and federal debt levels both on an absolute basis and versus earnings and GDP. The increase in leverage is made possible in part by low interest rates and QE. In addition, some Fed speakers over the last year or two have grumbled about higher than normal equity valuations.

It was for these very reasons that in 2013, Jerome Powell voiced concerns about the consequences of asset purchases (QE). To wit: 

“What of the potential costs or risks of the asset purchases? A variety of concerns have been raised over time. With inflation in check, the most important potential risk, in my view, is that of financial instability. One concern is that our policies might drive excessive risk-taking or create bubbles in financial assets or housing.”

Earlier this month, Jerome Powell, in Congressional testimony said:

“The debt is growing faster than the economy. It’s as simple as that. That is by definition unsustainable. And it is growing faster in the United States by a significant margin.”

With more leverage in the financial system and higher valuations in the equity and credit markets, how does Fed Chairman Powell reconcile those comments with where we are today? It further serves to highlight that political expediency has thus far trumped the long-run health of the economy and the financial system.

Based on the Fed’s prior and current warnings about debt and valuations, we believe they are trying to fix funding issues without promoting greater excesses in the financial markets. To thread this needle, they must supply just enough liquidity to restore financing markets to normal but not over stimulate them. This task is much easier said than done due to the markets’ Pavlovian response to QE.

Where the fed funds effective rate sits within the Fed’s target range can be a useful gauge of the over or undersupplying of liquidity. Based on this measure, it appears the Fed is currently oversupplying liquidity as seen in the following chart. For the first time in at least two years, as circled, the effective Fed Funds rate has been consistently below the midpoint of the Fed’s target range.

If the Fed is concerned with debt levels and equity valuations and is comfortable that they have provided sufficient liquidity, might they halt QE4, reduce monthly amounts, or switch to a more flexible model of QE?

We think all of these options are possible.

Any effort to curtail QE will be negative for markets that have been feasting on the additional liquidity. Given the symbiotic relationship between markets and QE, the Fed will be cautious in making changes. As always, the first whisper of change could upset the apple cart.

Summary

Equity markets have been rising on an almost daily basis despite benign economic reports, negative trade and tariff headlines, and Presidential impeachment proceedings, among other worrisome factors. We have little doubt that investors have caught QE fever again, and they are more concerned with the FOMO than fundamentals.

As the fresh round of liquidity provided by the Fed leaks into the markets, it only further advances more misallocation of capital, such as excessive borrowing by zombie companies and borrowing to further fund unproductive stock buybacks. Like dogs drooling at the sound of a ringing bell, most investors expect the bull run to continue. It may, but there is certainly reason for more caution this time around as the contours of the economy and the market are vastly different from prior rounds. Add to this the incoherence of this policy action in light of the record expansion, benign inflation readings, and low unemployment rate and we have more questions about QE4 than feasible answers.

To Buy, Or Not To Buy- An Investors Guide to QE 4

In no sense is this QE” – Jerome Powell

On October 9, 2019, the Federal Reserve announced a resumption of quantitative easing (QE). Fed Chairman Jerome Powell went to great lengths to make sure he characterized the new operation as something different than QE. Like QE 1, 2, and 3, this new action involves a series of large asset purchases of Treasury securities conducted by the Fed. The action is designed to pump liquidity and reserves into the banking system.

Regardless of the nomenclature, what matters to investors is whether this new action will have an effect on asset prices similar to prior rounds of QE. For the remainder of this article, we refer to the latest action as QE 4.

To quantify what a similar effect may mean, we start by examining the performance of various equity indexes, equity sectors, commodities, and yields during the three prior QE operations. We then normalize the data for the duration and amount of QE to project what QE 4 might hold in store for the assets.

Equally important, we present several factors that are unique to QE 4 and may result in different outcomes. While no one has the answers, we hope that the quantitative data and the qualitative commentary we provide arms you with a better appreciation for asset return possibilities during this latest round of QE. 

How QE 1, 2, and 3 affected the markets

The following series of tables, separated by asset class, breaks down price performance for each episode of QE. The first table for each asset class shows the absolute price return for the respective assets along with the maximum and minimum returns from the start of each QE. The smaller table below it normalizes these returns, making them comparable across the three QE operations. To normalize the data, we annualize the respective QE returns and then scale the returns per $100 billion of QE. For instance, if the S&P 500 returned 10% annualized and the Fed bought $500 billion of assets during a particular QE, then the normalized return would be 2% per $100 billion of QE.

Data in the tables are from Bloomberg.  Click on any of the tables to enlarge.

QE 4 potential returns

If we assume that assets will perform similarly under QE 4, we can easily forecast returns using the normalized data from above. The following three tables show these forecasts. Below the tables are rankings by asset class as well as in aggregate. For purposes of this exercise, we assume, based on the Fed’s guidance, that they will purchase $60 billion a month for six months ($360 billion) of U.S. Treasury Bills.

Takeaways

The following list provides a summarization of the tables.

  • Higher volatility and higher beta equity indexes generally outperformed during the first three rounds of QE.
  • Defensive equity sectors underperformed during QE.
  • On average, growth stocks slightly outperformed value stocks during QE. Over the last decade, inclusive of non-QE periods, growth stocks have significantly outperformed value stocks.
  • Longer-term bond yields generally rose while shorter-term yields were flat, resulting in steeper yield curves in all three instances. 
  • Copper, crude oil, and silver outperformed the S&P 500, although the exceptional returns primarily occurred during QE 1 for copper and crude and QE 1 and 2 for Silver.
  • On a normalized basis, Silver’s 10.17% return per $100bn in QE 2, is head and shoulders above all other normalized returns in all three prior instances of QE.
  • In general, assets were at or near their peak returns as QE 1 and 3 ended. During QE 2, a significant percentage of early gains were relinquished before QE ended.
  • QE 2 was much shorter in duration and involved significantly fewer purchases by the Fed.
  • The expected top five performers during QE4 on a normalized basis from highest to lowest are: Silver, S&P 400, Discretionary stocks, S&P 600, and Crude Oil. 
  • Projected returns for QE 4 are about two-thirds lower than the average of prior QE. The lesser expectations are, in large part, a function of our assumption of a smaller size for QE4. If the actual amount of QE 4 is larger than current expectations, the forecasts will rise.

QE, but in a different environment

While it is tempting to use the tables above and assume the future will look like the past, we would be remiss if we didn’t point out that the current environment surrounding QE 4 is different from prior QE periods. The following bullet points highlight some of the more important differences.

  • As currently planned, the Fed will only buy Treasury Bills during QE 4, while the other QE programs included the purchase of both short and long term Treasury securities as well as mortgages backed securities and agency debt. 
  • Fed Funds are currently targeted at 1.75-2.00%, leaving the Fed multiple opportunities to reduce rates during QE 4. In the other instances of QE, the Fed Funds rate was pegged at zero. 
  • QE 4 is intended to provide the banking system needed bank reserves to fill the apparent shortfall evidenced by high overnight repo funding rates in September 2019. Prior instances of QE, especially the second and third programs, supplied banks with truly excess reserves. These excess reserves helped fuel asset prices.
  • Equity valuations are significantly higher today than during QE 1, 2, and 3.
  • The amount of government and corporate debt outstanding is much higher today, especially as compared with the QE 1 and 2 timeframes.
  • Having achieved a record-breaking duration, the current economic expansion is old and best described as “late-cycle”.

Déjà vu all over again?

The prior QE operations helped asset prices for three reasons.

  • The Fed removed a significant amount of securities from the market, which forced investors to buy other assets. Because the securities removed were the least risky available in the market, investors, in general, moved into riskier assets. This had a circular effect pushing investors further and further into riskier assets.
  • QE 4 appears to be providing the banks with needed reserves. Assuming that true excess reserves in the system do not rise sharply, as they did in prior QE, the banks will probably not use these reserves for proprietary trading and investing. 
  • Because the Fed is only purchasing Treasury Bills, the boost of liquidity and reserves is relatively temporary and will only be in the banking system for months, not years or even decades like QE 1, 2, and 3.

Will QE 4 have the same effect on asset prices as QE 1, 2, and 3?

Will the bullish market spirits that persisted during prior episodes of QE emerge again during QE 4?

We do not have the answers, but we caution that this version of QE is different for the reasons pointed out above. That said, QE 4 can certainly morph into something bigger and more akin to prior QE. The Fed can continue this round beyond the second quarter of 2020, an end date they provided in their recent announcement. They can also buy more securities than they currently allude to or extend their purchases to longer maturity Treasuries or both. If the economy stumbles, the Fed will find the justification to expand QE4 into whatever they wish.

The Fed is sensitive to market returns, and while they may not want excessive valuations to keep rising, they will do anything in their power to stop valuations from returning to more normal levels. We do not think investors can blindly buy on QE 4, as the various wrinkles in Fed execution and the environment leave too many unanswered questions. Investors will need to closely follow Fed meetings and Fed speakers for clues on expectations and guidance around QE 4.

The framework above should afford the basis for critical evaluation and prudent decision-making. The main consideration of this analysis is the benchmark it provides for asset prices going forward. Should the market disappoint despite QE 4 that would be a critically important contrarian signal.

To Buy or not to Buy : Thoughts on Crude Oil

When a team manages a portfolio, as we do at RIA Advisors, investment decisions can be complicated by differing viewpoints. While such debates are frustrating, opposing opinions help make the case to trade or not to trade stronger, which tends to lead to better results.

Currently, Lance Roberts and Michael Lebowitz are discussing the merits of adding crude oil and/or energy stocks to our portfolios. In this article, we share with you part of the debate. We lead with Michael who, while not yet committed, is watching on a key technical signal before pushing for a long position in crude oil and/or energy stocks. The signal is based on the Commitment of Traders Report (COT) published by the Commodity Futures Trading Commission (CFTC). Lance’s opinion, following Michael’s, is based on a fundamental outlook as well as more traditional technical indications. 

Michael’s View

The weekly COT reports details the open interest of a wide variety of commodity futures contracts and options on those contracts. Open interest refers to the net long or short position for each contract or option. Total open interest always nets to zero as there must be a seller for every buyer. To make the report worthwhile the CFTC segments data by the business purpose of each firm or individual that has an open position. The four categories are as follows: Producers, Banks/Brokers, Managed Money, and Other. The net positions of each account type provide valuable information that helps traders understand why a contract is trading the way it is, but also how it might trade in the future.

Many traders pay particular attention to the managed money accounts as they tend to be the marginal transactors, and therefore price setters, in many futures/commodities markets. Frequently, when a large number of managed money accounts are positioned similarly, contract prices ultimately tend to reverse. Such a situation brings to mind the adage about everyone being on one side of a boat.

Currently, the crude oil market is nearing a situation where managed money accounts are relatively bearish. Per the latest COT report for WTI Crude Oil, net longs (the difference between open long and short positions) are at +277,211 contracts. These managers are still net long which can be construed as bullish, but as shown on the graph below, the number of net longs are small in context with COT data since 2014.

As shown by the dotted red line, the current level of net long positioning by managed money accounts is the lowest since 2016. Given that many managed money accounts tend to chase momentum, and oil has fallen 30% since October 2018, the relatively low net long number is not a surprise.

Chasing momentum can be very profitable until it’s not.

When you are trading based on momentum its vital to recognize when the underlying instrument is in an overbought or oversold condition. Conditions can certainly stay overbought or oversold, but at some point, the proverbial boat tips and everyone scurries to the other side. Those accurately anticipating these shifts can profit handily.

The graph below plots the correlation between oil and managed money net positions.

,While some degree of correlation is obvious, it’s not apparent from the graph how well one would do trading solely based on a small net long position. To help, we provide the table below showing price returns for various net position levels over different holding periods. We do this for crude oil and the popular energy ETF XLE, which at times is well correlated to oil. The green highlighted cells represent the best opportunity in terms of length of trade and the net long position.

Unfortunately, COT data is still delayed due to the government shutdown. The CFTC will be reporting twice a week until they catch up. As of early January 2019, the net long position was 277,211, a sharp decline from over 700,000 a year ago.

Lance’s View

Two things are worth considering about the current trend and direction of oil.

The first is simply the long-term dynamics of what is happening with oil.

Currently, the global economy is slowing, and the demand side of the equation is failing to keep up with the growing supply of oil. Despite cuts from OPEC, Russia, and others, the “shale revolution” is adding to supply faster than the cuts to production can account for.

Given that oil is a highly sensitive indicator relative to the expansion or contraction of the economy, and that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness.

The chart below combines interest rates, inflation, and GDP into one composite indicator to provide a clearer comparison to oil prices. One important note is that oil tends to trade along a pretty defined trend…until it doesn’t. Given that the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which have a negative impact on the manufacturing and CapEx spending inputs into the GDP calculation.

As such, it is not surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates.

Since October of 2018, the price of oil has signs of global economic weakness have grown. Despite the occasional rally, it’s hard to see the outlook for oil is encouraging on both fundamental and technical levels.

The charts for WTI remain bearish, while the fundamentals remain basically “Economics 101: too much supply, too little demand.” The parallel with 2014 is there if you want to see it.

The current levels of supply potentially create a longer-term issue for prices globally particularly in the face of weaker global demand due to demographics, energy efficiencies, and debt.

Many point to the 2008 commodity crash as THE example as to why oil prices are destined to rise in the near term. The clear issue remains supply as it relates to the price of any commodity. With drilling in the Permian Basin expanding currently, any “cuts” by OPEC have already been offset by increased domestic production.

As noted in the chart above, the difference between 2008 and today is that previously the world was fearful of “running out” of oil versus worries about an “oil glut” today. The issues of supply versus price become clearer if we look further back in history to the last crash in commodity prices which marked an extremely long period of oil price suppression as supply was reduced.

The fundamental backdrop doesn’t look to improve anytime soon which brings us to the purely technical aspect of oil.

The graph below compares the price of crude oil and energy stocks. As you can see, there is a high correlation between the two. This is not surprising given the impact of the commodity on revenues and profitability for these companies.

From a purely technical perspective, the price of oil remains confined below the 1-year, 2-year, and 5-year moving averages. What this suggests is that prices are going to remain under downward pressures which will likely correspond with the onset of a recession in the next 12- to 24-months.

Again, this is a weekly chart, so things move a bit more slowly. In the very short-term oil is oversold enough, and as Mike noted above, there are certainly catalysts which could push both oil prices and energy-related stocks higher in the short-term.

However, the longer-term backdrop remains negative and corresponds highly with a late stage economic cycle.

As always, “timing is everything.”

Trade Recommendation

Because of the rather weak technical and fundamental outlook for oil that Lance laid out in conjunction with our agreement that economic growth will slow considerably over the next few quarters, we have agreed that patience is the best course of action for now. However, we have not ruled out taking a long position in oil, with a tight stop, if the net long managed money position drops below 225,000.

We will keep you posted if we take any action in oil or energy companies.

The Coming Age of Real Assets

What do these four periods have in common?

  • 1861-1865
  • 1916-1920
  • 1941-1950
  • 2010-2018

On close inspection, the first three eras are periods of major U.S. military conflicts (The Civil War, World War I, and World War II), but you may be wondering why we included the recent, post financial crisis era. The reason is that these four instances are periods of excessive monetary stimulus. The chart below, recently published by JP Morgan Asset Management, illustrates average real yields in 5-year periods since 1830.

As shown, historical periods of negative real yields (market interest rates below the rate of inflation) developed out of the dire need to fund deficit-spending associated with the massive cost of those wars.

In stark contrast with those major events, that is not what is happening today. The current period is a remarkable anomaly as it stems not from war but from years of financial chicanery and monetary policy experimentation. This period is something altogether different and will certainly have consequences that many fail to anticipate.

We have been frequent critics of the Federal Reserve (Fed) and the other major central banks for all their various forms of so-called sound central banking policies. The manufactured stimulus resulting from interest rate manipulation and money printing aimed at forcing stock prices higher has wide ranging effects. Some are easily noticeable in the short term and other distortions and consequences will only be observable over longer periods of time. This article discusses one such distortion that presents an investment opportunity in the making.

As discussed in Wicksell’s Elegant Model, when the market rate of interest is held below the natural rate of interest (a proxy for economic growth) as has been the case since the financial crisis, capital tends to get misallocated on a vast scale. Companies and investors that can borrow at ultra-low cost are more incentivized to re-invest in existing assets. They do not need or want to take on the risk and time demands of deploying capital into new long-term projects. This is even truer today as executive compensation packages, laden with stock options, reward such behavior.

The result is a price boom in existing financial assets such as stocks and bonds. Because capital is largely directed to financial assets, commerce increasingly shuns investment in new property, plant and equipment and gravitates toward takeover bids for existing competitors, share buybacks and larger dividends.

Financial asset transactions, however, do not lead to an expansion of the capital stock. They are only a transfer in the ownership of assets which primarily results in a net increase of total debt. Economic growth during such environments has little organic sponsorship. Instead, the growth realized is largely, superficially fueled by debt and, as a result, temporary.

Money Message

Part of the reason financial engineering and speculation has taken precedence over real capital investment is that investors lack a sound basis for making long-term investment and project decisions. Exchange rates and interest rates are a reflection of money as a store of value and therefore a vital conduit of information. When policymakers tamper with either or both, they distort that flow of information, thus handicapping investors in their ability to properly assess the current and future value of goods and services. Under those circumstances, few business managers are willing to take on the risk of investing in new plant and equipment especially after adjusting for the probability of failure. The easiest solution to that problem is to borrow heavily at low interest rates and reinvest in assets offering an existing stream of income. This produces a reasonable return on investment with much better visibility.  

One of the more compelling charts we have seen in the last year is the long-term relationship between the S&P 500 and the Goldman Sachs Commodities Index (GSCI). No chart better illustrates the distortion of uses of capital as described above. The following chart highlights the divergence between financial assets, using the S&P 500 as a proxy, which have exploded in price and real assets such as those found in the commodities complex.

To offer a more detailed perspective, the next chart highlights the contrast in price returns between the S&P 500 and the Commodities Research Bureau (CRB) commodities index along with the ratio between the two gauges.

If the negative real interest rate regime of the post-crisis era has indeed obscured the pricing mechanism of money and reinforced the preference for financial assets, it should also be negatively reflected in real assets. Using the CRB index as a proxy as shown below, we notice that commodity prices are at levels seen over 20 years ago.

Despite negative real rates and rising marginal costs of production, two factors that have historically supported commodity prices, they continue to remain under pressure. Additionally, while China’s appetite for raw materials has diminished somewhat, plans for the massive One-Belt, One-Road (OBOR), the new silk road, continue to advance as do the commodity requirements for that project.

Opportunities in Commodities

If as we suspect, the low interest rate environment has been an important dynamic in financial asset price inflation, then normalizing interest rates may also bring gradual normalization of investor preferences.

Such an adjustment could be an impetus towards more investment in durable cash flow projects and less in speculative financial assets. Over time this would be disruptive to stock prices and beneficial for commodities.

From a value perspective, commodities are relatively cheap as an asset class and some specific components in particular have been depressed for quite some time. Since 2017, sugar is down -35%, coffee is down -45% and natural gas is down -28%.

Taking a longer view, since 2014 corn and soybeans are down -11% and -28% respectively while lean hogs are down -44% and sugar is down -22%. Last we checked, the global population is not shrinking and the likelihood that demand for these basic necessities will fall seems low.

Add to the equation the supply restraints of harvesting or mining resulting from environmental disruptions and this out of favor asset class could begin to surprise to the upside. In a world where everyone seems inclined to pay top dollar for the latest fad, these staples of global society certainly warrant close monitoring.

Summary

Low interest rates have disrupted the normal functioning transmission mechanism of the price of money and prudent decision-making has been obscured as a result of these extensive price controls. This has led investors, corporate managers and entrepreneurs to take evasive actions, avoid risks, and lever up cheap money to go for the sure thing. The irony is that although this produces favorable short-term results, it impairs the intermediate and long-run growth potential of the economy.

Given the slow and methodical process promised by the Fed, any normalization may take time. Then again, if concerns around inflation begin to emerge, the normalization of interest rates may be forced to accelerate. Commodities have been a big underperformer since 2011 as investors shunned real assets over financially engineered options. Although the turn may not be here quite yet, the commodity sector stands to eventually benefit and is one place with a lot of options to look for value.

Those who see that the last 10-years of experimental stimulus has been on par with, or arguably exceeded, policies historically reserved for major wars gain a unique and valuable perspective of the current monetary mirage. The demise of those policies, as they are bound to unravel, will reveal a multitude of investment opportunities left behind in the ill-advised euphoria of anti-capitalism.

Key Charts To Watch As Crude Oil’s Bust Continues

Crude oil’s plunge continued on Tuesday due to fears of a growing glut and economic slowdown. West Texas Intermediate crude oil fell 7.3% to $46.24 a barrel, while Brent crude oil fell 5.6% to $56.26 a barrel. Crude oil’s ongoing bear market confirms the warning I published on November 6th called “Is A Crude Oil Liquidation Event Ahead?”

After today’s drop, West Texas Intermediate crude oil is down approximately 40% since early-October:

WTI Crude Daily

Brent crude oil is down approximately 35% since early-October:

Brent Crude Oil Daily

In recent weeks, WTI crude oil broke below its uptrend line that started in early-2016 and the key $50 level, both of which are important technical breakdowns. The next price targets to watch are $40, then $30, and so on.

WTI Crude Weekly

Brent crude oil recently broke below both its uptrend line and its key $60 level, which is a bearish omen that puts $50, $40, and $30 into play as the next price targets/support levels to watch.

Brent Weekly

As I discussed a few weeks ago, crude oil is plunging because it is pricing in much slower economic growth and a likely recession, as well as growing inventories. I am particularly worried about plunging oil prices because I believe that it is going to pop the shale energy bubble that I have been warning about for years.

Here’s what I wrote in Forbes in 2014:

I am also growing increasingly concerned that the U.S. shale energy boom is actually another post-2009 economic bubble (it would be a part of the commodities bubble). In a zero-percent interest rate environment like we are currently experiencing, any economic boom can devolve into a bubble. Shale energy extraction is a very capital-intensive business that relies heavily on cheap credit to survive. Shale oil wells experience much faster decline rates than conventional oil wells, which means that energy companies must keep drilling at a furious pace just to maintain their production – a very costly proposition that is typically funded by copious amounts of debt.

Here’s what I wrote in Forbes in September 2018, when I summarized the shale energy bubble:

U.S. shale energy boom/energy junk bonds: This boom/bubble is closely related to the corporate debt bubble discussed above. Extracting oil and gas from shale via fracking is extremely capital-intensive and would not be feasible in a normal interest rate environment. Thanks to the artificially low interest rate environment since the Great Recession, the shale energy industry’s net debt surged to $200 billion in 2015 – a 300% increase from 2005. Rising interest rates and the bursting of the corporate debt/junk bond bubble will cause a major bust in the shale energy industry.

The oil price plunge and overall rising interest rate environment is causing high yield or “junk” bonds to sink. The chart below shows that the HYG high yield corporate bond ETF recently broke below a key technical level known as a neckline, which is a signal that further bearish action is likely ahead (which means that junk bond yields will rise). I believe that this is yet another sign that the shale energy bubble is at risk of popping.

HYG

For now, I am watching $40 and $50 a barrel as the next price targets in WTI and Brent crude oil. The HYG high yield corporate bond ETF is likely to gun for its early-2016 lows in the course of this energy bust.

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As Seen On Forbes: American Farm Bankruptcies Are On The Rise

As seen on Forbes by RealInvestmentAdvice.com’s Jesse Colombo: “Here’s Why More American Farms Are Going Bankrupt.”

A report came out this week showing that U.S. farm bankruptcies are on the rise due to falling agricultural product prices as well as rising interest rates:

The increase in Chapter 12 filings reflects low prices for corn, soybeans, milk and even beef. The situation for most farmers has worsened since June under retaliatory tariffs that have closed the Chinese market for soybeans and damaged exports of milk and pork.

Farmers use Chapter 12 bankruptcy because it combines the simplicity of Chapter 13 bankruptcy — usually used by individuals — and the higher debt levels allowed with Chapter 11 bankruptcy — usually used by corporations. The Chapter 12 process typically allows for repayment of debt over three years.

Mark Miedtke, the president of Citizens State Bank in Hayfield, Minn., said bankruptcy hasn’t reared its head for borrowers in his area of southeast Minnesota, but farmers are struggling.

“Dairy farmers are having the most problems right now,” Miedtke said. “Grain farmers have had low prices for the past three years but high yields have helped them through. We’re just waiting for a turnaround. We’re waiting for the tariff problem to go away.”

This chart shows how farm bankruptcies have been increasing since 2014:

Farm Bankruptcy

Read the full article on Forbes.

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Why Oil’s Crash Will Cause A Shale Energy Bust

Despite this being a low-volume holiday week, crude oil continues to plunge. West Texas Intermediate (WTI) crude oil is down $3.69 or 6.75% and Brent crude oil is down $3.60 or 5.75% today alone, which further confirms the concerns I had when when I wrote the article “Is A Crude Oil Liquidation Event Ahead?” on November 6th. In that piece, I warned that WTI crude oil’s technical breakdown below its key $65 level would likely lead to even more bearish action, which could then cause speculators or the “dumb money” to violently liquidate their large bullish position of nearly 500,000 net futures contracts. In today’s update, I will show the next key technical levels to watch and discuss the economic implications of crude oil’s crash of the past two months.

The daily chart shows how WTI crude oil fell by over $26 per barrel or 34% since early October:

WTI Crude Oil Daily

Brent crude oil fell by over $28 per barrel or 33% since early October:

Brent Crude Daily

WTI crude oil keeps slicing below important technical levels: $60, $55, and the uptrend line that began in early-2016, which represents a very important and concerning technical breakdown. The next major support level to watch is $50; if WTI crude oil breaks below $50 in a convincing manner, it will likely try to gun for $40, then $30, and so on.

WTI Crude Oil Weekly

Brent crude oil sliced below its $70 and $60 support levels along with the uptrend line that started in early-2016, which is a very bad omen that increases the probability of further bearish action provided it isn’t negated by a close back above this level.

Brent Crude Oil Weekly

As I’ve been pointing out since the start of this year, crude oil futures speculators or the “dumb money” (the red line under the chart) have built a massive long position in WTI crude oil of just under 500,000 net futures contracts. There is a very real risk that these speculators will be forced to liquidate if the sell-off continues, which would greatly exacerbate the sell-off.

Dumb Money

Why is crude oil selling off so sharply? There are a number of reasons, but the core reason is that global recession risk is rising (which is why the stock market is selling off along with oil). According to the Ned Davis Research chart below, global recession risk is now above 70.

What does that mean?

“Readings above 70 have found us in recession 92.11% of the time (1970 to present).  Several months ago, the model score stood at 61.3.  It has just moved to 80.04.  Expect a global recession.  It either has begun or will begin shortly.  Though no guarantee, as 7.89% of the time since 1970 when the global economic indicators that make up this model were above 70, a recession did not occur.” – Stephen Blumenthal

Global Recession Risk

In September, I wrote a popular Forbes piece called “How Interest Rate Hikes Will Trigger The Next Financial Crisis” in which I showed how historic recessions, banking, and financial crises have occurred after interest rate hike cycles (the chart below is from that piece). I believe that dangerous bubbles have formed in emerging markets, U.S. stocks, the shale energy industry/energy junk bonds, tech startups, and other industries and countries after the Great Recession, and that rising interest rates are going to pop those bubbles and cause yet another financial and economic crisis.

Fed Funds Rate

I am particularly worried about plunging oil prices because I believe that it is going to pop the shale energy bubble that I have been warning about for years.

Here’s what I wrote in Forbes in 2014:

I am also growing increasingly concerned that the U.S. shale energy boom is actually another post-2009 economic bubble (it would be a part of the commodities bubble). In a zero-percent interest rate environment like we are currently experiencing, any economic boom can devolve into a bubble. Shale energy extraction is a very capital-intensive business that relies heavily on cheap credit to survive. Shale oil wells experience much faster decline rates than conventional oil wells, which means that energy companies must keep drilling at a furious pace just to maintain their production – a very costly proposition that is typically funded by copious amounts of debt.

Here’s what I wrote in Forbes in September 2018, when I summarized the shale energy bubble:

U.S. shale energy boom/energy junk bonds: This boom/bubble is closely related to the corporate debt bubble discussed above. Extracting oil and gas from shale via fracking is extremely capital-intensive and would not be feasible in a normal interest rate environment. Thanks to the artificially low interest rate environment since the Great Recession, the shale energy industry’s net debt surged to $200 billion in 2015 – a 300% increase from 2005. Rising interest rates and the bursting of the corporate debt/junk bond bubble will cause a major bust in the shale energy industry.

The oil price plunge and overall rising interest rate environment is causing high yield or “junk” bonds to sink. The chart below shows that the HYG high yield corporate bond ETF recently broke below a key technical level known as a neckline, which is a signal that further bearish action is likely ahead (which means that junk bond yields will rise). I believe that this is yet another sign that the shale energy bubble is at risk of popping.

High Yield Bonds

Fund manager Jeff Gundlach said that he expected that the Fed would raise rates “until something breaks.” There is a good chance that one of the first things that broke and continues to break is crude oil prices and the shale energy bubble. This has very serious implications because it is one of the most important drivers of economic activity and job creation in the U.S. since the Great Recession. Society is going to be taught the lesson that cheap credit and flooding the economy and financial system with liquidity leads to bubbles rather than sustainable economic booms.

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Here’s What To Watch As Oil’s Liquidation Sell-Off Continues

Last week, I wrote a piece in which I warned about the risk of a sharp liquidation sell-off in the crude oil market as speculators are forced to jettison their massive 500,000 futures contract long position. Since then, crude oil continues to sell off very hard and was down nearly 8% on Tuesday alone. Crude oil is an economically sensitive asset and may be selling off as it prices in the rising risk of a recession in the not-too-distant future.

West Texas Intermediate (WTI) crude oil broke below its key $65 support level at the start of this month and tested the $55 support level during Tuesday’s sell-off. There is a good chance of a short-term bounce at the $55 level. If WTI crude oil eventually closes below the $55 support level in a decisive manner, it would likely foreshadow further weakness.

Crude Oil Daily

The weekly chart shows how WTI crude oil recently broke below its uptrend line that started in early-2016 (just like the S&P 500 did), which is a worrisome sign.

Crude Oil Weekly

As I’ve been pointing out since the start of this year, crude oil futures speculators or the “dumb money” (the red line under the chart) have built a massive long position in WTI crude oil of just under 500,000 net futures contracts. There is a very real risk that these speculators will be forced to liquidate if the sell-off continues, which would greatly exacerbate the sell-off.

Crude Oil Monthly

After going sideways for five months, the U.S. dollar has recently resumed its rally that started in the spring. On Monday, the U.S. Dollar Index broke above its key 97 resistance level that formed at the index’s peak in August. If the index manages to stay above this level, it may signal even more strength ahead. The dollar is strengthening because U.S. interest rates have been rising for the past couple years, which makes the U.S. currency more attractive relative to foreign currencies.

The U.S. Dollar Index is very important to watch due to its significant influence on other markets, particularly commodities and emerging market equities. Bullish moves in the U.S. dollar are typically bearish for commodities (including energy and metals) and emerging markets, and vice versa. If the U.S. Dollar Index continues to rise after Monday’s breakout, it would spell even more pain for commodities and EMs.

Dollar

For now, I am watching how WTI crude oil acts at its key $55 support level and if the U.S. dollar’s Monday breakout holds.

If you have any questions about anything I wrote in this piece or would like to learn how Clarity Financial can help you preserve and grow your wealth, please contact me here.

Do You Really Need Half Your Money In Stocks?

We’ve all been conditioned to think the balanced portfolio is a touchstone of investing. For many investors, it provides enough exposure to the stock market (60%) to produce a healthy return and enough exposure to the bond market (40%) to provide ballast and a little income to a portfolio. Along the way, advisors like to say that investors have counted on beating inflation by 4 or 5 percentage points. Supposedly.

But, as MarketWatch’s Brett Arends points out, a balanced portfolio hasn’t always performed as advertised, and the upcoming decade might be one of those times. That means investors should consider other allocations (depending on their individual circumstances, of course).

First, from 1938 to 1948, a balanced portfolio trailed inflation. Then, again, from 1968 through 1983, a balanced portfolio trailed inflation, eroding a third of its value in real terms, according to Arends. Basically, a balanced portfolio struggles against inflation. And while it’s obvious why inflation hurts bonds with their fixed dollar payments, it also tends to hurt stocks, despite their assumed ability to benefit from companies passing on higher costs to customers through price increases.

There aren’t easy ways for investors to combat inflation, if it should arise. Gold and commodities helped in the 1970s. Real estate can help too, as inflation can cause property price appreciation and push rents higher. Some foreign stock markets might help. Arends points out that Japanese and Singaporean stocks took off in the 1970s. Corporate bank loans and floating rate corporate debt might also help, though, Arends notes Ben Inker of Grantham, Mayo, van Otterloo (GMO) in Boston says credit protections aren’t what they once were. Finally, Inker notes that cash is a reasonable choice in times of inflation. And cash, as Arends says, doesn’t have to be in U.S. dollars. It can be in Swiss Francs, for example.

The 1970 also saw observers like Harry Browne advocate a different kind of portfolio mix – 25% each in cash, long-term bonds, stocks, and commodities. The cash and commodities would help in inflation, while the long-term bonds would help in times of deflation.

That leads me to the argument that, if you’re going to maintain a static portfolio allocation, something like 30% stock exposure, with the rest in short-term bonds and cash might be reasonable for someone about to retire soon. My reasons are that stocks are too volatile for a portfolio in distribution, and they’re likely too expensive to deliver good future returns in any case.

First, although I cherry-picked the start date so that two severe bear markets are baked into this hypothetical study, this portfolio in distribution phase shows that 30% stock exposure is better for a retiree in a bear market than a more aggressive portfolio. A balanced portfolio worked reasonably well, but only dropping down to 30% stocks allowed the portfolio to remain intact in a nominal sense (though not in an inflation-adjusted sense). Taking money from a portfolio during a volatile stock market is a tricky business. Too much stock exposure – even when using the famous “4% rule” (4% withdrawal the first year and 4% more than the first withdrawal annually thereafter) can destroy someone’s retirement.

Second, it’s not clear that stocks will outperform bonds over the next decade in any case. Even if you’re not in distribution phase, making volatility less of a concern, you may not add return to your portfolio by adding stock exposure. That’s because the Shiller PE (current price of stocks relative to past 10-year inflation-adjusted earnings) is over 30, meaning stocks have to remain more expensive than they have in history barring one other time for the next decade to deliver more than a 4% or 5% return.

And if you do add U.S. stocks to your portfolio, you’ll likely be adding the same old volatility stocks have delivered in the past. Modern academic finance like to use something called the Sharpe Ratio, which is a volatility-adjusted return or indicates how much return an investment achieved per unit of volatility. This view of the world has its problems, because risk might not be volatility, but it can be useful in helping you decide whether you want to add a certain asset to a portfolio or not. Getting, say, 4% or 5% annualized from stocks and assuming their historical volatility is a lot worse than getting the customary 10% from stocks and assuming their customary volatility. Adding U.S. stocks to a portfolio at current prices makes for what modern academic finance would call an inefficient portfolio.

Foreign stocks are cheaper than their U.S. counterparts, but they’re not screamingly cheap. If a balanced portfolio seems reasonable to you, it may not be under today’s circumstances. Consider trimming at least some of that stock exposure and adding a few other asset classes. Those new additions may not shoot the lights out, but, chances are, neither will U.S. stocks for the next decade. Above all, don’t think there’s some rule that says you need half your money in stocks. The idea of the balanced portfolio has become so popular that it feels like heresy to some people to deviate from it. But investing isn’t about faith; it’s about assessing the circumstances and likely returns in as rational a way as possible. Remember also to get some help from an adviser in constructing a portfolio and completing a financial plan. Many asset classes that weren’t available in the past to retail investors are available now. An experienced adviser can help you use them well and manage the risks they contain.

Recession Ahead? Watch Dr. Copper

After selling off this summer, copper has been consolidating over the last couple months and appears to be forming a wedge-type pattern that may indicate another strong move when the metal breaks out from it one way or another. Copper has a reputation for leading the global economy and is known as “the metal with a PhD in economics.” As our Chief Investment Strategist Lance Roberts recently showed, there is a rising risk of a recession, and the financial markets may be starting to price this in.

If copper breaks down from its most recent wedge pattern, it would be a worrisome sign for the global economy. The next price target and support level to watch is the $2.5 per pound support level that came into play over the last couple years.

Copper Daily Chart

The weekly chart below puts the current wedge and support levels into perspective. If copper breaks down from its wedge, the next support to watch is $2.5 and, after that, $2 per pound.

Copper Weekly Chart

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

Is A Crude Oil Liquidation Event Ahead?

West Texas Intermediate (WTI) crude oil is down approximately 20% since the start of October, putting it into bear market territory. Crude oil’s rout is due largely to reduction of the severity of the sanctions placed by the U.S. on Iran as well as the financial market and economic fears that have resurfaced in the past month.

WTI crude oil broke below the key $65 per barrel level, which is now a resistance level, which is a sign of technical weakness. Crude oil would need to close back above this level in a convincing manner in order to negate this breakdown.

Crude Oil Daily

The weekly crude oil chart shows how WTI crude oil broke below its uptrend line that started in mid-2017. If the breakdown remains intact, the next key level and price target to watch is the $55 support level that formed at the late-2016/early-2017 highs.Crude Oil Weekly

As I’ve been pointing out since the start of this year, crude oil futures speculators or the “dumb money” (the red line under the chart) have built a massive long position in WTI crude oil of just under 500,000 net futures contracts. There is a very real risk that these speculators will be forced to liquidate if the sell-off continues, which would greatly exacerbate the sell-off.

Crude Oil Monthly

Crude oil is an economically sensitive asset and may be selling off as it prices in the rising risk of a recession in the not-too-distant future.

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

UPDATE: Drilling for Value – Southwestern Energy (SWN)

Since recommending Southwestern Energy Company (SWN) for purchase on September 13th, the stock has exceeded our expectations. It currently trades at $5.50, or about 10% above the recommended price.

Given SWN’s extreme volatility, we recommended a stop-loss protection order as follows:  “Using the charts as a framework, one can enter a long SWN position with a downside stop loss of 4.55 (4.70 less a 3% cushion).”

Given the recent surge in price, SWN has put us in a unique opportunity to “play with the houses money.”

We think investors heeding our advice should increase the stop loss from $4.55 to $5.00. This allows us to participate in further upside, assuming the bottoming pattern of higher-highs and higher-lows continues to play out, and at the same time it greatly limits our potential loses.

The original article is below.

Disclaimer: This material is subject to change without notice. This document is for information and illustrative purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation.


We have made it clear on numerous occasions that there are not many value propositions available in the equity markets for long-term shareholders. Most recently in Allocating on Blind Faith, we highlighted how three widely followed valuation levels portend low single-digit returns for the coming decade. While a dismal outlook that does not mean that opportunities do not exist.

One asset class in particular that continues to catch our attention is commodities. The following graph shows how cheap the Goldman Sachs Commodity Index (GSCI) has become compared to the S&P 500. In the same way that a metal detector can identify the location of possible treasures, this graph provides a strong signal there is potential value in commodity-linked investments. Those inclined must simply “dig.”

Within the commodity sector, we have a few stocks that are on our watch list for possible investment. In this article, we explore one of them, Southwestern Energy Company (SWN). SWN is a natural gas exploration and production company headquartered in Texas. It is somewhat unique in the energy sector as it is one of a few publically traded companies that are almost entirely focused on natural gas. Most of SWN competitors have much higher exposures to oil and other energy products. In 2017, for instance, 97% of SWN’s revenue was derived from the production, transportation, and marketing of natural gas (NG).

By using both a technical and fundamental examination, we can better assess whether SWN is worth owning.

Technical Study

We start our technical study with a short-term graph covering the last 12 months and then expand further back in time for a broader context as to where SWN has traded, relevant trends, support and resistance levels, and what that might portend for the future.

SWN appears to have bottomed following a significant decline over the last few years. There is reason to believe a true bottom has formed as shown in the one-year graph below. Three bullish buy signals based on the Moving Average Convergence Divergence (MACD) indicator have occurred as indicated by the dotted vertical lines. Additionally, the 50-day moving average crossed over the 200-day moving average in July. Further a strong support line (gold dotted line) has formed and has been tested successfully on numerous occasions. Currently, the support line is near $4.70 which provides a solid level to establish risk parameters for a potential trade. That price level, less a 3% cushion ($4.55), should serve well as a stop loss acting as a trigger to reduce or eliminate the position and risk if SWN closes below that price level.

The longer term, 10-year chart below provides a different perspective of SWN. Since 2014, SWN has declined by almost 90%. However, since March it has shown signs of bottoming. While the shorter-term chart leaves room for optimism, the longer-term chart certainly gives reason for pause.

The current price ($5.00) is not far from the 3-year downtrend resistance line ($5.74) which has capped every rally since 2014.  If SWN were to convincingly close through that 3-year resistance line, it would greatly improve our longer-term confidence and appetite for risk.

Also of concern, the stock is considered overbought based on the Williams % Ratio (momentum indicator). We are not overly concerned with the Williams % Ratio as the ratio can stay at extreme levels for long periods without resulting in a meaningful change in the direction of a security’s price.

If SWN is reversing the decline of the prior years, we would like to see it establish a pattern of higher highs and higher lows. Thus far, that has only recently begun to occur but six months certainly does not make a dependable trend.

The technical picture for SWN is tilted somewhat favorably as it allows us to establish guardrails for taking additional risk. Using the charts as a framework, one can enter a long SWN position with a downside stop loss of 4.55 (4.70 less a 3% cushion). At the same time, if the upside trendline is broken the next price target is the November 2017 high of 6.72. The gain/loss ratio of the potential short-term upside target (6.72) to the downside stop loss target (4.55) is over 4:1, a compelling data point.

Fundamentals

The sharp decline in the share price of SWN compressed the valuation multiples that investors were willing to pay. In 2007, for instance, SWN’s price to sales ratio was over 10. Since then it has steadily eroded to its current level of 1. Price to trailing 12 months earnings (P/E) has also cheapened significantly, having steadily dropped from the mid 20’s to its current level of 8.80.

As a point of comparison, consider that SWN reported revenue of $763.11mm and EBITDA of $397.17mm in the fourth quarter of 2006. In the most recent earnings release, revenue was reported at $3,282mm (3.3x greater than 2006) and EBITDA was $914mm (1.3x greater than 2006). At the same time, the market cap (number of shares outstanding times the stock price) is currently $3,296mm versus $5,897mm at the end of 2006. Simply put, investors are getting a lot more for their money than in prior years.

From a liquidity perspective, SWN total liabilities have declined significantly over the last four years. Its ratio of long-term debt to equity now stands at 158% versus over 1000% in 2015. While financial leverage is not as great as it was, we are in turn provided a greater level of comfort in their ability to service the debt.

Among the many fundamental indicators we use to evaluate stocks for inclusion in our portfolios, two are worth emphasizing. They are the Piotrosky F Score and Mohanram Score.

  • The Piotrosky F Score uses nine factors to determine a company’s financial strength in profitability, financial leverage and operating efficiency. Currently, SWN scores a very favorable 8 on a scale of 1 to 9.
  • The Mohanram Score uses eight factors to determine a company’s financial strength in earnings and cash flow profitability. SWN scores a 5 on a scale of 1 to 8.

Of additional interest Zacks has strong ratings in various metrics as follows:

  • Zacks Rank 2  (1-5, 1 being the highest)
  • Growth Score B (A-F, with A being the highest)
  • Value Score A (A-F, with A being the highest)
  • Momentum Score A (A-F, with A being the highest)
  • VGM Score A (A-F, with A being the highest)

SWN is trading at a much cheaper valuation compared to years past. That said, we must remain vigilant as SWN relies on one product, NG. Swings in the price of NG due to ever-changing supply and demand variables can be violent and earnings can change sharply.

Seasonals

Our time-tested, long-range formula is pointing toward a very long, cold, and snow-filled winter,” -Peter Geiger in a statement on the Farmers’ Almanac website.

We start this section with the obvious disclaimer that we are not weathermen. Nor would we recommend an investment based on a weather forecast. That said the weather outlook can greatly affect sentiment and the demand for NG and therefore affect SWN’s earnings and stock price.

In the short run, it behooves us to understand how the expectations for a cold winter, as is expected by some long-range meteorologists, and the potential for rising NG prices might affect the price of SWN. The graph below shows a significant one-year rolling correlation between the prices of NG and SWN and therefore short-term holders should consider that weather could easily play an outsized role in the pricing of SWN.

Next, we compare how NG has performed by month. In particular, we are looking for seasonal outperformance or underperformance patterns in respective months that might be weather-related.

As shown, NG has produced the highest average gains in September and October over the past 27 years. This is likely due to a combination of pre-winter expectations for higher NG prices as well as hedging activity taking place in NG. Further, those months were also affected in certain years by seasonal hurricane activity which can temporarily boost the price of NG.

Interestingly, note that the months of January and February, despite what is frequently peak NG usage, tend to be poor months for NG price performance. The winter months are when the rubber hits the road and NG prices fail, at times, to live up to the expectations formed in the summer and fall months.

Given SWN’s strong correlation to NG, we should keep these seasonal tendencies in mind.

Summary

In a market dearth of value, we think SWN provides an interesting opportunity. While its longer-term trend is poor, its recent trading performance and solid fundamentals provide what appears to be a constructive asymmetry of risk and reward. Further seasonal patterns in NG and speculative forecasts for a cold winter argue for a boost in the short-term.

On the basis of those factors, SWN appears more than fairly priced and cheap compared to most other stocks with a compelling upside-to-downside ratio. Despite the seasonal volatility associated with the weather, the fundamentals argue that SWN represents decent value and might prove to be a good long-term hold. Further, it provides some measure of diversification as it tends to be poorly correlated with the stock market.

All data in the article was provided by Zacks and the graphs from Stockcharts.com

Disclaimer: This material is subject to change without notice. This document is for information and illustrative purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation.

Drilling for Value – Southwestern Energy (SWN)

We have made it clear on numerous occasions that there are not many value propositions available in the equity markets for long-term shareholders. Most recently in Allocating on Blind Faith, we highlighted how three widely followed valuation levels portend low single-digit returns for the coming decade. While a dismal outlook that does not mean that opportunities do not exist.

One asset class in particular that continues to catch our attention is commodities. The following graph shows how cheap the Goldman Sachs Commodity Index (GSCI) has become compared to the S&P 500. In the same way that a metal detector can identify the location of possible treasures, this graph provides a strong signal there is potential value in commodity-linked investments. Those inclined must simply “dig.”

Within the commodity sector, we have a few stocks that are on our watch list for possible investment. In this article, we explore one of them, Southwestern Energy Company (SWN). SWN is a natural gas exploration and production company headquartered in Texas. It is somewhat unique in the energy sector as it is one of a few publically traded companies that are almost entirely focused on natural gas. Most of SWN competitors have much higher exposures to oil and other energy products. In 2017, for instance, 97% of SWN’s revenue was derived from the production, transportation, and marketing of natural gas (NG).

By using both a technical and fundamental examination, we can better assess whether SWN is worth owning.

Technical Study

We start our technical study with a short-term graph covering the last 12 months and then expand further back in time for a broader context as to where SWN has traded, relevant trends, support and resistance levels, and what that might portend for the future.

SWN appears to have bottomed following a significant decline over the last few years. There is reason to believe a true bottom has formed as shown in the one-year graph below. Three bullish buy signals based on the Moving Average Convergence Divergence (MACD) indicator have occurred as indicated by the dotted vertical lines. Additionally, the 50-day moving average crossed over the 200-day moving average in July. Further a strong support line (gold dotted line) has formed and has been tested successfully on numerous occasions. Currently, the support line is near $4.70 which provides a solid level to establish risk parameters for a potential trade. That price level, less a 3% cushion ($4.55), should serve well as a stop loss acting as a trigger to reduce or eliminate the position and risk if SWN closes below that price level.

The longer term, 10-year chart below provides a different perspective of SWN. Since 2014, SWN has declined by almost 90%. However, since March it has shown signs of bottoming. While the shorter-term chart leaves room for optimism, the longer-term chart certainly gives reason for pause.

The current price ($5.00) is not far from the 3-year downtrend resistance line ($5.74) which has capped every rally since 2014.  If SWN were to convincingly close through that 3-year resistance line, it would greatly improve our longer-term confidence and appetite for risk.

Also of concern, the stock is considered overbought based on the Williams % Ratio (momentum indicator). We are not overly concerned with the Williams % Ratio as the ratio can stay at extreme levels for long periods without resulting in a meaningful change in the direction of a security’s price.

If SWN is reversing the decline of the prior years, we would like to see it establish a pattern of higher highs and higher lows. Thus far, that has only recently begun to occur but six months certainly does not make a dependable trend.

The technical picture for SWN is tilted somewhat favorably as it allows us to establish guardrails for taking additional risk. Using the charts as a framework, one can enter a long SWN position with a downside stop loss of 4.55 (4.70 less a 3% cushion). At the same time, if the upside trendline is broken the next price target is the November 2017 high of 6.72. The gain/loss ratio of the potential short-term upside target (6.72) to the downside stop loss target (4.55) is over 4:1, a compelling data point.

Fundamentals

The sharp decline in the share price of SWN compressed the valuation multiples that investors were willing to pay. In 2007, for instance, SWN’s price to sales ratio was over 10. Since then it has steadily eroded to its current level of 1. Price to trailing 12 months earnings (P/E) has also cheapened significantly, having steadily dropped from the mid 20’s to its current level of 8.80.

As a point of comparison, consider that SWN reported revenue of $763.11mm and EBITDA of $397.17mm in the fourth quarter of 2006. In the most recent earnings release, revenue was reported at $3,282mm (3.3x greater than 2006) and EBITDA was $914mm (1.3x greater than 2006). At the same time, the market cap (number of shares outstanding times the stock price) is currently $3,296mm versus $5,897mm at the end of 2006. Simply put, investors are getting a lot more for their money than in prior years.

From a liquidity perspective, SWN total liabilities have declined significantly over the last four years. Its ratio of long-term debt to equity now stands at 158% versus over 1000% in 2015. While financial leverage is not as great as it was, we are in turn provided a greater level of comfort in their ability to service the debt.

Among the many fundamental indicators we use to evaluate stocks for inclusion in our portfolios, two are worth emphasizing. They are the Piotrosky F Score and Mohanram Score.

  • The Piotrosky F Score uses nine factors to determine a company’s financial strength in profitability, financial leverage and operating efficiency. Currently, SWN scores a very favorable 8 on a scale of 1 to 9.
  • The Mohanram Score uses eight factors to determine a company’s financial strength in earnings and cash flow profitability. SWN scores a 5 on a scale of 1 to 8.

Of additional interest Zacks has strong ratings in various metrics as follows:

  • Zacks Rank 2  (1-5, 1 being the highest)
  • Growth Score B (A-F, with A being the highest)
  • Value Score A (A-F, with A being the highest)
  • Momentum Score A (A-F, with A being the highest)
  • VGM Score A (A-F, with A being the highest)

SWN is trading at a much cheaper valuation compared to years past. That said, we must remain vigilant as SWN relies on one product, NG. Swings in the price of NG due to ever-changing supply and demand variables can be violent and earnings can change sharply.

Seasonals

Our time-tested, long-range formula is pointing toward a very long, cold, and snow-filled winter,” -Peter Geiger in a statement on the Farmers’ Almanac website.

We start this section with the obvious disclaimer that we are not weathermen. Nor would we recommend an investment based on a weather forecast. That said the weather outlook can greatly affect sentiment and the demand for NG and therefore affect SWN’s earnings and stock price.

In the short run, it behooves us to understand how the expectations for a cold winter, as is expected by some long-range meteorologists, and the potential for rising NG prices might affect the price of SWN. The graph below shows a significant one-year rolling correlation between the prices of NG and SWN and therefore short-term holders should consider that weather could easily play an outsized role in the pricing of SWN.

Next, we compare how NG has performed by month. In particular, we are looking for seasonal outperformance or underperformance patterns in respective months that might be weather-related.

As shown, NG has produced the highest average gains in September and October over the past 27 years. This is likely due to a combination of pre-winter expectations for higher NG prices as well as hedging activity taking place in NG. Further, those months were also affected in certain years by seasonal hurricane activity which can temporarily boost the price of NG.

Interestingly, note that the months of January and February, despite what is frequently peak NG usage, tend to be poor months for NG price performance. The winter months are when the rubber hits the road and NG prices fail, at times, to live up to the expectations formed in the summer and fall months.

Given SWN’s strong correlation to NG, we should keep these seasonal tendencies in mind.

Summary

In a market dearth of value, we think SWN provides an interesting opportunity. While its longer-term trend is poor, its recent trading performance and solid fundamentals provide what appears to be a constructive asymmetry of risk and reward. Further seasonal patterns in NG and speculative forecasts for a cold winter argue for a boost in the short-term.

On the basis of those factors, SWN appears more than fairly priced and cheap compared to most other stocks with a compelling upside-to-downside ratio. Despite the seasonal volatility associated with the weather, the fundamentals argue that SWN represents decent value and might prove to be a good long-term hold. Further, it provides some measure of diversification as it tends to be poorly correlated with the stock market.

All data in the article was provided by Zacks and the graphs from Stockcharts.com

Disclaimer: This material is subject to change without notice. This document is for information and illustrative purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation.

 

‘Dr. Copper’ Plunges In Worrisome Sign For The Global Economy

As if the recent turmoil in Turkey, South Africa, and other emerging markets wasn’t enough, commodities including copper are now sinking as well. Copper, which is known as “the metal with a PhD in economics” due to its historic tendency to lead the global economy, is down nearly 4 percent today alone and 22 percent since early-June. Copper’s bear market of the past couple months is worrisome because it signals that a global economic slowdown is likely ahead.

The chart below shows how copper was bouncing around in a range between $3 and $3.3 per pound until it peaked and broke down in June:

Copper Daily Chart

The longer-term chart shows how copper surged after Donald Trump’s election win (due to expectations of an infrastructure boom), climbed within a channel pattern, and then broke down from the channel in late-2017. The $2 per pound support is the next major level to watch if copper’s bearish trend continues.

Copper Weekly ChartCopper and other base metals are falling for a wide variety of reasons including the plunge in Turkey and other emerging markets, the strengthening U.S. dollar, and China’s economic slowdown due to the trade war. If the dollar continues to rise and the emerging markets turmoil spreads (which I ultimately expect to happen), there is a high likelihood that copper will continue its downward trend.

Viewing Employment Without Rose-Colored Glasses

Fed Officials Worry Economy Is Too Good. Workers Still Feel Left Behind” – New York Times 4/27/2018

This coming Friday the Bureau of Labor Statistics (BLS) will release the monthly employment report. Consensus expectations from economists are for an unemployment rate (U3) of 4.1% which is nearly unprecedented in the last fifty years.

On April 26, 2018, the Department of Labor reported that a mere 209,000 people filed for initial jobless claims. This weekly amount was the lowest since 1969. The data point is the lowest in almost 50 years and remarkable when normalized for the number of people considered to be of working age (ages 15-64).

Low initial jobless claims coupled with the historically low unemployment rate are leading many economists to warn of tight labor markets and impending wage inflation. If there is no one to hire, employees have more negotiating leverage according to prevalent theory. While this seems reasonable on its face, further analysis into the employment data suggests these conclusions are not so straightforward. This was recently raised by the New York Times as highlighted in the lead quote above.

Strong Labor Statistics

The following chart highlights initial jobless claims adjusted for the working age population (ages 15-64).

Data Courtesy: St. Louis Federal Reserve

As shown above, there is only one person filing an initial jobless claim for every thousand people in the workforce. This is less than half the average (dotted line) of the last 50 years. Further, when one considers seasonal workers that will always be filing claims, regardless of the health of the economy, this number may be reaching the lowest point conceivable.  Regardless, the current low rate of jobless claims is unprecedented.

The U-3 unemployment rate, as calculated by the BLS, is also at a level that implies an incredibly strong labor market. Except for the year 2000 when it dipped to a low of 3.8%, the most recent reading of 4.1% is the lowest since 1969.

Adjusting Labor Statistics for Reality

The data mentioned above suggests that the job market is on fire. While we would like nothing more than to agree, there is other employment data that contradicts that premise.

If there are very few workers in need of a job, then current workers should have pricing leverage over their employers.  This does not seem to be the case as shown in the graph of personal income below.

Data Courtesy: St. Louis Federal Reserve

In addition to the weak wage growth, we are also troubled by another labor statistic, the participation rate. This indicator measures employed people and those “looking for work” as a percentage of those aged 16 and older. During economic recessions, the ratio tends to decline as unemployed workers get discouraged and stop looking for work. Conversely, it tends to increase when the labor market is healthy.

The participation rate graphed below shows that, despite nine years of economic recovery since the 2008 financial crisis, the participation rate has trended lower and clearly broken the trend from the prior 20 years.

Data Courtesy: St. Louis Federal Reserve

Closer inspection of the BLS data reveals that, since 2008, 16 million people were reclassified as “leaving the workforce”. To put those 16 million people into context, from 1985 to 2008, a period almost three times longer than the post-crisis recovery, a similar number of people left the work force.

Some economists may be tempted to push back on this analysis by claiming the drop in the participation rate is attributable to a large number of baby boomers retiring. While it is true 10,000 boomers will reach age 65 daily from the year 2011 to 2030, we must also consider that 11,500 children a day will turn 16 during that same period. Not all 16-year-olds will seek work or be gainfully employed, but we must also consider that many baby boomers will stay in the workforce.  According to recent Pew Research surveys, boomers do not believe “old age” begins until the age of 72. Taken together, this suggests the demographic explanation may not explain the inconsistencies found in the “full-employment” assumption.

Why are so many people struggling to find a job and terminating their search if, as we are repeatedly told, the labor market is so healthy? To explain the juxtaposition of the low jobless claims number and unemployment rate with the low participation rate and weak wage growth, a calculation of the participation rate adjusted unemployment rate is revealing.

When people stop looking for a job, they are still unemployed, but they are not included in the U-3 unemployment calculation. If we include those who quit looking for work in the data, the employment situation is quite different. The graph below compares the U-3 unemployment rate to one that assumes a constant participation rate from 2008 to today. Contrary to the U-3 unemployment rate of 4.1%, this metric implies an adjusted unemployment rate of 9.1%.

Data Courtesy: St. Louis Federal Reserve and Real Investment Advise

Enter the Phillips Curve

The Phillips curve, named after William Phillips, is a simple measure describing the inverse relationship between the unemployment rate and wage inflation. The logical premise behind the Phillips Curve is that, as unemployment drops and workers become harder to find, workers can demand higher wages. Conversely, when unemployment rises, the supply of workers is greater, and therefore wages fall. The Phillips curve follows the basic tenets of the supply and demand curves for most goods and services.

Many economists and media pundits have pronounced the Phillips curve relationship dead as it relates to employment. They deem it an economic relic that has ceased to provide reliable results. Has a basic, time-tested law of supply and demand ceased to work in the labor markets, or are economists measuring the inputs incorrectly? 

There are a large number of social and economic factors that affect wages and the supply of workers. We do not ignore those factors, but it is a good exercise to observe the Phillips curve relationship if one uses the more “realistic” unemployment rate (9.1%) shown above. Further, we substitute wage growth one-year forward for the traditional method of using current wage growth. The logic here is that it takes time for employees to apply the leverage they gain over employers to boost their income.

The first graph below shows the traditional Phillips curve as typically displayed (U-3 and recent three-month wage growth). The second is a modified Phillips curve which uses the adjusted U-3 from above and one-year forward wage growth.

Both graphs contain their respective R-squared (R²), which shows the statistical relationship between the two factors. The traditionally calculated Phillips Curve (first graph) demonstrates that only 28.84% of the change in wages was due to the change in the unemployment rate. Visual inspection also tells us the relationship between wages and unemployment is weak. It is this graph that has many economists declaring the Phillips curve to be irrelevant. The second graph, with our adjustments, is statistically significant as 70.47% of the changes in wages were due to the change in the unemployment rate. This graph visibly confirms that the Phillips curve relationship for employment continues to hold when more representative data is used.

Recently, Federal Reserve Bank of Chicago President Charles Evans stated, in relation to the Phillips curve, “We don’t have a great understanding of why it’s gotten to be so flat.” Mr. Evans, perhaps employment is not as strong as you and your Fed colleagues think it is.

If one believes that the laws of supply and demand continue to hold true, then the revised Phillips curve graph above argues that the unemployment rate is in reality much closer to 9% than 4.1%. To believe that the Phillips curve is useless, one must be willing to ignore a more rigorous assessment of labor market and wage data. The only reason economists and Fed officials voluntarily ignore this data is that it belies the prettier picture of the economy they wish to paint.

Summary

One of the main factors driving the Federal Reserve to raise interest rates and reduce its balance sheet is the perceived low level of unemployment. Simultaneously, multiple comments from Fed officials suggest they are justifiably confused by some of the signals emanating from the jobs data. As we have argued in the past, the current monetary policy experiment has short-circuited the economy’s traditional traffic signals. None of these signals is more important than employment. Logic and evidence argue that, despite the self-congratulations of central bankers, good wage-paying jobs are not as plentiful as advertised and the embedded risks in the economy are higher. We must consider the effects that these sequences of policy error might have on the economy – one where growth remains anemic and jobs deceptively elusive.

Given that wages translate directly to personal consumption, a reliable interpretation of employment data has never been more important. Oddly enough, it appears as though that interpretation has never been more misleading. If we are correct that employment is weak, then future rate hikes and the planned reduction in the Fed’s balance sheet will begin to reveal this weakness soon.

As an aside, it is worth noting that in November of 1969 jobless claims stood at 211,000, having risen slightly from the lows recorded earlier that year. Despite the low number of claims, a recession started a month later, and jobless claims would nearly double within six months. This episode serves as a reminder that every recession followed interim lows in jobless claims and the unemployment rate. We are confident that the dynamics leading into the next recession will not be any different.

Nowhere to Hide

The following article was originally a PowerPoint presentation that highlights several aspects of recent price movements across assets classes and within equity industry sectors. Many investors are unfamiliar with these relationships and their importance. While the current correction may prove only to be a speed bump on the way to higher prices, close inspection of asset class and security interactions often hold important clues about the future. The information contained in these pages argues for caution.

Click on any table below for a full size image making them easier to read.

Nowhere to Hide

The messages from shifting cross asset and S&P 500 sector correlations


Why Correlations Matter

Correlation is a statistical measure that quantifies the relationship between two financial assets or securities. A correlation of +1.0 is perfect, meaning the two securities or assets move one-for-one with each other. A correlation of -1.0 means they move exactly opposite of each other. As correlations move away from +/- 1.0 the relationship weakens. A correlation of zero quantitatively implies no relationship in the movement between the two instruments.

Correlations between and within asset classes plays an integral role in portfolio management. From a big picture perspective, changing correlations can be a signal that broader market trends are changing. Investors may reduce risk during such periods. Also of importance, changing correlations may increase or decrease the value of “hedges” within a portfolio. For instance, investors tend to assume they are taking a more defensive posture moving technology to utility stocks, or from stocks to bonds when they sense a downturn coming. While such trades have been effective in the past, correlations allow us to observe changes and develop opinions about the future.

The following charts and notes provide recent and historical context on how correlations have changed since the equity market turned lower in late January. Whether these changes turn out to be a dependable warning of trend change, or a multi-month anomaly, is unknown. What is known is that the market is not behaving as it has for the last few years and investors should pay close attention to correlations for more market insight.


Under Appreciated Price Action

This graph, courtesy of Goldman Sachs, shows how correlations between S&P 500 stocks have increased at a rate greater than anytime in the last 40 years except 1987.


Cross Asset Correlations







S&P 500/UST Correlation

Given the popularity of formal and informal risk parity strategies, this graph showing the well below average correlation of the S&P 500 versus 10 year UST yields should be of vital concern if this equity sell-off continues and the correlation remains low.


S&P 500 Sector Correlations



To further highlight the uniqueness of current sector correlations versus the S&P 500, this graph compares the current period (green dots) versus the prior year (orange squares) and the prior 15 years (gray triangles).


Something is different this time

This graph serves as a reminder that passive investing has grown significantly over the past 10 years. In our opinion this popularity will play a role in making it more likely that correlations between asset classes and sectors will behave differently in the next downturn than they have in the past. As such alternative hedging strategies should be considered now.


Conclusions

  • Passive funds and strategies have increased the likelihood that future correlations between asset classes and the S&P 500 and its constituents are higher
  • Equity and fixed income correlations have increased recently, rendering fixed income hedges for equities not as dependable
  • Gold and commodities as measured by the CRB index have also not been as good an equity hedge as in the past
  • Long equity volatility (VIX) has thus far proven a good ballast for stock and fixed income hedging
  • Traditional safety, low beta, equity sectors have been well correlated to other sectors and the equity market as a whole
  • Higher beta equity indexes (Russel 2k and the NASDAQ) have moved nearly perfectly in line with the S&P 500
  • It is too early to tell if the market is topping or just taking a breather, but the signals discussed in this article and others we did not highlight, should be taken seriously

Here’s What To Watch In Crude Oil Right Now

After experiencing weakness in February and March, crude oil spiked to three-year highs in April due to geopolitical fears associated with the Syria bombing campaign as well as falling inventories. Earlier today, President Trump tweeted that OPEC was to blame for “artificially Very High!” crude oil prices, which he said are “No good and will not be accepted!” In this piece, we will look at key technical levels and other information relevant for understanding crude oil prices.

Since the summer of 2017, crude oil has been climbing a series of uptrend lines, but broke below one of these lines during the market rout of early-February 2018. WTI crude oil broke above its $66-$67 resistance last week, which is a bullish technical signal if it can be sustained. If WTI crude oil breaks back below this level, however, it would be a bearish sign.WTI Crude Daily

A major reason for skepticism about crude oil’s recent rally is the fact that the “smart money” or commercial futures hedgers currently have their largest short position ever – even larger than before the 2014/2015 crude oil crash. The “smart money” tend to be right at major market turning points. At the same time, the “dumb money” or large, trend-following traders are the most bullish they’ve ever been. There is a very good chance that, when the trend finally changes, there is going to be a violent liquidation sell-off.

WTI Crude Monthly

Similar to WTI crude oil, Brent crude has been climbing a couple uptrend lines as well. The recent breakout over $71 is a bullish sign, but only if it can be sustained; if Brent breaks back below this level, it would give a bearish confirmation signal.

Brent Crude Daily

It is worth watching the U.S. Dollar Index to gain insight into crude oil’s trends (the dollar and crude oil trade inversely). The dollar’s bearish action of the past year is one of the main reasons for the rally in crude oil. The dollar has been falling within a channel pattern and has recently formed a triangle pattern. If the dollar can break out of the channel and triangle pattern to the upside, it would give a bullish confirmation signal for the dollar and a bearish signal for crude oil (or vice versa). The “smart money” or commercial futures hedgers are currently bullish on the dollar; the last several times they’ve positioned in a similar manner, the dollar rallied.

USD Weekly

The euro, which trades inversely with the dollar and is positively correlated with crude oil, is also worth watching to gain insight into crude oil’s likely moves. The “smart money” are quite bearish on the euro, which increases the probability of a pullback in the not-too-distant future. The euro has been rising in a channel pattern and has recently formed a triangle pattern. If the euro breaks down from this channel, it would give a bearish confirmation signal, and would likely put pressure on crude oil (or vice versa).Euro Weekly

There has been a good amount of buzz about falling inventories and the reduction of the oil glut, but this week’s inventories report of 427.6 million barrels is still above average for the past 5 to 10 years. In addition, U.S. oil production continues to surge and recently hit an all-time high of 10.5 million barrels per daily.

For now, the short-term trend in crude oil is up, but traders should keep an eye on the $66-$67 support zone in WTI crude oil and the $71 support in Brent crude oil. If those levels are broken to the downside, then the recent bullish breakout will have proven to be a false breakout. Traders should also keep an eye on which way the U.S. dollar and euro break out from their triangle and channel patterns.

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Crude Oil Breaks Out, But Will It Last?

For the past several weeks, I’ve been watching triangle patterns form in crude oil after its slide in early-February. Breakouts from triangle patterns often lead to important directional moves, which is why I believe it is worthwhile to pay attention to these formations. Both WTI and Brent crude oil finally broke out of their triangle patterns today due to Middle East tensions and speculation regarding more cuts in Venezuelan output.

Here’s West Texas Intermediate crude oil’s breakout:

WTI Crude Daily

Here’s Brent crude oil’s breakout:

Brent Crude DailyWhile I believe in respecting price trends instead of fighting them, I’m still concerned about the fact that crude oil’s rally of the past two years has been driven by “dumb money” or large speculators, who are more aggressively positioned than they were in the spring of 2014 before the oil crash. At the same time, the “smart money” or commercial hedgers have built their largest short position in history.

WTI Crude Monthly

Last week, I showed that U.S. Treasuries had broken out of triangle patterns of their own. Crude oil’s recent bullish move has been threatening the Treasury breakout (the two markets trade inversely):

30 Year Bond

10 Year Note

The U.S. Dollar Index is worth paying attention to when analyzing the crude oil market. Bullish moves in the dollar are typically bearish for crude oil and other commodities, and vice versa. Today’s bullish crude oil move and breakout is not confirmed by the U.S. Dollar Index, which is up .64 percent today. The U.S. Dollar Index has been trading in a directionless manner for the past two months, but its next major trend is likely to affect crude oil. If the Dollar Index can break above its trading range and downtrend line, it would likely lead to further bullish action (which would hurt crude oil). If the Dollar Index breaks down from its trading range, however, it would likely lead to further bearish action (which would push crude oil higher).

Dollar Daily

The longer-term U.S. Dollar Index chart shows that it is trading in a downward-sloping channel pattern. The dollar will remain in a downtrend as long as it trades within this channel. A breakout from this channel would increase the probability of a rebound, which would hurt crude oil. As I’ve been showing, the “smart money” or commercial hedgers are bullish, while the dumb money are bearish.

Dollar Weekly

This is an admittedly confusing time in the financial markets: correlations are breaking down, many technical breakouts and breakdowns are failing and whip-sawing, and the market is chopping all over the place. For these reasons, I’m not making any short-term market predictions, but just showing key charts that I believe are worth paying attention to. Yes, I believe they must be taken with a healthy grain of salt. I am suspicious of today’s crude oil breakout because it’s not confirmed by the U.S. dollar and because of the large bearish position held by the “smart money.” The smart money are usually right in the end, but it’s not prudent to fight the trend in the short-term. As usual, I will keep everyone posted regarding the recent crude oil and Treasury bond breakouts.

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