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Category: Chart of the Week

Why CPI Numbers Suggest Interest Rates Are Too Low Vs. Inflation

The following chart from Shadow Statistics by John Williams compares the official government Consumer Price Index (CPI) with the significantly higher CPI that Williams calculates if the index was measured by pre-1990 methodology when interest rates generally were higher than inflation.  Williams believes that there’s been a sharp deterioration in the last couple of decades in the methodology the government uses to calculate CPI and it doesn’t reflect what consumers and businesses are really experiencing. In any case, both present government-calculated CPI and Williams’ “shadow” CPI show that the current 3% interest rates result in a nominally negative return. What does this mean? Interest rates are likely to go up 2% to 3% to more realistic levels.

Beware: Default Rates Could Be Set To Explode

Debt as a percent of nominal GDP has approached a 30-year high (yellow line), while defaults are hovering at all-time lows (green line). Why does that matter to you? Over the last three decades debt accumulation tended to occur several quarters before the default rates began to accelerate.  This setup, illustrated in the chart,  indicates that a large amount of defaults in the debt market are set to occur again. That historically leads to an increase in interest rates which can have a negative impact on the stock market and other risk assets. Sincere thanks go out to Rodd Mann, who shared the chart with us.

Just How Stretched is the Consumer?

Liz Ann Sonders, Chief Strategist for Charles Schwab, has created her own formula to determine just how much stress the consumer is feeling. Clearly, since 2014 stress has increased sharply. But, this comes at a time when consumer confidence is at highs.

In addition, recessions appear to occur at levels above zero on the chart. Currently, we are above those levels.

The great thing about Sonders’ formula is it factors in expenses that hit us all in the real world. Things like food and energy costs the government typically downplays. My energy costs have gone up and I can clearly feel that. I also just received an increase in my healthcare costs starting next month. That money has to come from somewhere! If it comes out of discretionary spending, then the local coffee shop and grocery store will start to feel the pain. The recessions form.

There’s one factor clearly stressing out the consumer. Student loan debt. And, this might understate the pain an entire generation of Americans are feeling. While consumer confidence is at highs, 44 million Americans have $1.4 trillion in student loan debt. That compares to $640 billion during the crisis of 2008. In addition, home ownership among has fallen from 32% in 2007 to 21% in 2016. The weight of this debt is crushing.

If consumer confidence is high but consumers are also stressed, then what gives? Well, sometimes people say one thing and do another. I would always take government statistics with a grain of salt. Debt levels aren’t going away and incomes aren’t growing.

The next recession is likely to be a doozy!

This Indicator is Flashing Warning Bells for the Market

By John Del Vecchio

The New York Stock Exchange (NYSE) Bullish Percent index is creating a potential bearish divergence with the S&P 500. This could be suggesting a lot of weakness under the hood of the market.

The bullish percent is the percentage of stocks in bullish patterns using point and figure charting. Point and figure charting has been around since before 1900 and is a simple chart showing price movement (X’s for up and O’s for down). It makes it easy to see trends in the prices of stocks. In addition, stocks are either on a “buy” or a “sell” so the analysis could not be clearer.

The beauty of the NYSE Bullish Percent is that is shows stocks moving up and down in the aggregate. Importantly, each stock gets a single vote. This differs from the S&P 500 because the S&P is market capitalization weighted. So, a stock like Apple gets significantly more weight than Waste Management. The top 5 stocks in the S&P 500 are 12-15% of the total index. In the NYSE Bullish Percent, they are all the same.

Most people use the S&P 500 when they talk about “the market”. But, what’s going on in the market could be quite a bit different than what is going on with the typical stock. We can see this in the chart below.

The green line is the S&P 500. The blue line is the NYSE Bullish Percent. Prior to the butt kicking the S&P took in February, both of these lines mostly moved in tandem. The S&P made new highs as did the bullish percent.

But, recently that relationship has weakened. The S&P 500 has rebounded and is close again to new highs. Small cap indexes hit new highs recently as well. However, the bullish percent figures are lagging. The one stock, one vote nature of the index is letting you know that not as many issues are participating in the rise of “the market.”
You might see this in your own portfolio. The market may be making new highs but your holdings are lagging. In healthy markets, we expect to see lots of stocks making new highs. At the very least, we would like to see them back into uptrends.

That’s not happening.

The danger here is that by the time the S&P 500 rolls over, the average stock could be down 10-20%. This is useful gauge to monitor the health of the market in aggregate.

Right now, it is sending off some warning bells that things are not as strong as they appear to be.

Watch this Trend for Changing Stock Market Fortunes

By John Del Vecchio

I like to look for extremes in the markets. Extremes often pinpoint areas where returns can be higher and risk lower than in other time periods. Take the relationship between commodities and stocks. The chart below shows that commodities haven not been cheaper than stocks in a generation.

Could the relationship between commodities and stocks have changed forever? Possibly. We often hear “this time it is different” to justify what’s going on in the world. But, one thing that never changes is human nature.

People push markets to extremes. Then they revert.

You see this in the real world. Have you ever noticed in a basketball game that a team gets really hot in the first half of the game? Blazing hot. The players are nailing three pointers and outside jumpers and guys coming off the bench score more in the first half than they typically do in a game.

Then in the second half the team falls apart. They can’t buy a layup. Meanwhile, the opponent plays a bit better and catches up. The hot team has reverted to their mean.

It happens all the time.

When markets revert, there can be big returns with much less risk.

So, what to do with commodities and stocks? Well, the stock market has had one of the longest bull runs in history. We are way overdue for a meaningful pullback. Commodities are cheap relative to stocks. But, that doesn’t automatically make them a screaming buy. They have been below the median level for six years and headed lower! Additionally, we could have a deflationary bust that wipes out wealth beyond comparison.

What it means to me is to raise cash, not allocate fresh capital to stocks and be on the lookout for changes in trends in the stock market. These generational lows won’t hold. So, it will pay to watch this trend going forward to look for the beginnings of the reversion to the mean. It could make you a lot of money. But, more importantly, shield you from big losses in stocks.

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