Everyone’s a Winner

Monday, 18 May 2020
Melbourne, Australia
By Greg Canavan

Stock markets around the world continue to push higher.

Is it investors pricing in a solid recovery from the enforced lockdown? Or is it simply central bank liquidity finding a home?

Let’s have a look through some data and charts, and see whether we can come up with an answer…

First, from Doug Noland’s Credit Bubble Bulletin:

Federal Reserve Assets surged $213bn last week to a record $6.934 TN, pushing the 10-week gain to $2.693 TN. M2 “money supply” (with a week’s lag) expanded another $199bn, with a 10-week rise of $2.257 TN. Institutional Money Fund Assets (not included in M2) added $15bn, boosting its 10-week expansion to $961bn.

In just over two months, the US Federal Reserve has expanded its balance sheet by nearly US$2.7 trillion.

That is, it has gone into the market and bought up US$2.7 trillion worth of assets. Most of it has gone towards buying US Treasuries. But the Fed has also created US$114 billion worth of new loans and US$444 billion in currency swaps with other central banks.

Where has all this cash (liquidity) gone?

Well, to say it has ‘gone into’ the stock market is not quite right. Cash ‘goes through’ the stock market, not into it.

Cash is low returning. Banks want to hold as little of it as they need to. The cash in your bank account isn’t just sitting there waiting for you to access it. The bank has lent it out to someone else. If everyone tried to get their cash at once, the system would collapse.

In financial markets, cash moves around constantly. It moves through the stock market, making bids at certain prices. People offload it like a hot potato. That’s why US$2.7 trillion in fresh liquidity can add many times that value onto the market.

So we can safely say that the big rally from the lows has a lot to do with central bank liquidity injections.

What about valuations? Do they support the rebound?

Let’s have a look at the most important stock market in the world, the S&P 500. According to data cruncher Ed Yardeni, the S&P 500 currently trades on a forward price-to-earnings (PE) multiple of 20.2 times. The forward estimates are a time weighted average of FY20 and FY21 consensus estimates.

Using FY21 consensus forecasts (as at 7 May), the PE multiple falls to 17.24.

That’s still high in a historical context. And it’s especially high if you’re sceptical about earnings jumping 30% in FY21, as predicted by the numbers.

But with US 10-year bond yields at just 0.64%, is a PE multiple of 17 times…or 20 times for that matter, really all that expensive?

It’s a question worth thinking about.

But for today, I want to focus on the narrower issue of whether we are in a liquidity fuelled rally or a sustainable bounce.

Let’s check out some charts…

As you know, most stock markets around the world are all bouncing strongly. If the rally were due to a genuine prospect of a strong economic rebound, I’d expect to see a number of ‘risk-off’ assets falling in price.

For example, bond yields should be heading higher (meaning prices should be falling) as they factor in a rebound in economic growth next year. But as I just mentioned, the 10-year US bond yield is just 0.64%. The Aussie rate is 0.92%.

My charting software doesn’t have bond data, but as you can see from the chart below, the Aussie bond yield is still at very low levels, despite rising from the trough reached in March.

The Insider

Source: Market Watch

I know central banks are in there buying and pushing yields lower. But if market players genuinely thought growth was going to rebound strongly, I doubt yields would still be so low.

If Aussie yields can push above 1% and move higher, that will be a sign of economic recovery. Until then, at the very least, I’m sceptical.

Let’s look at the US dollar. It’s generally a good sign of global liquidity conditions. That is, when the US dollar is falling, it’s often a sign of strong global growth, credit creation, ample liquidity etc. But when it’s on the rise, it’s the opposite.

As you can see below, the US Dollar Index is in a strong upward trend. This suggests that, despite the Fed’s best efforts, underlying global US dollar liquidity is still tight. That is, we’re not back to a ‘normal’ global growth environment.

The Insider

Source: Optuma

The other ‘risk-off’ currency that is moving higher now too, is the yen. Given it’s moving higher against the already strong US dollar, that’s saying something. Buying the yen is a classic defensive play. That it’s trending higher now is telling you something…

The Insider

Source: Optuma

What about gold?

When things are looking up, this defensive asset usually sells off. But that’s not happening this time around. Gold is again approaching its high of US$1,788, reached in mid-April.

Will it blast through to new highs?

The Insider

Source: Optuma

My only reservation is the waning momentum (as measured by the RSI) over the past few months. But still, gold is in a long-term upward trend and looks strong. In addition, gold equities (the HUI Index) just broke out to a level not seen since 2013, as you can see below.

The Insider

Source: Optuma

While prices are certainly stretched in the short term, the recent powerful move is bullish.

Given you’re seeing a rally in ‘risk on’ AND ‘risk off’ assets, it’s a reasonable conclusion to suggest that central bank liquidity is lifting nearly all boats at the moment. Everyone’s a winner.

Will it levitate the market until a recovery takes shape, or should you brace yourself for more falls?

For the recovery thesis to gain traction, you want to see bond yields moving higher, gold selling off and commodities (and oil) recovering. Until that happens, I’m sceptical…and cautious.


For more market analysis, read on below for Murray Dawes’ ‘The Week Ahead’…


The Short Squeeze Continues
By Murray Dawes


[Click on the picture to watch Murray’s analysis of gold, Brent crude oil and the S&P 500. All are pointing up for now, but the bigger picture looks different in each.]

In today’s ‘Week Ahead’ update I have a look at gold, oil and the S&P 500.

All three are looking constructive for more upside in the short term, but only gold has little resistance above current prices.

Gold is now within sniffing distance of the all-time high at US$1,920. It is only a matter of time until we see prices heading above there.

Oil is in recovery mode after a historic crash. A weekly buy pivot was confirmed a couple of weeks ago after prices had a false break of multiyear support. Until we see a weekly sell pivot, I would expect to see further buying pressure in Brent crude prices towards the point of control of the wave down in the crash. That is just below $44.00 or 35% above current prices of $32.50.

The S&P 500 is continuing to thrash around in a tight range with large selling forces above, but a weekly uptrend is still intact.

After testing weekly support and holding last week, we should expect to see some buying pressure early in the week towards overhead resistance. The key levels to watch are 2,888 and 2,912 in the E-mini S&P 500 futures where selling pressure could reemerge.

If prices head above the recent high of 2,965 we should see another wave higher within the weekly uptrend, which could take prices up into the major resistance zone of 3,000–3,100.

We are in a difficult trading environment and traders need to stay on their toes. We may see another spike higher in prices in the near term, but there is huge resistance above the market in the S&P 500. Buyers need to keep their eyes on the exits and bears need to remain aware that the short squeeze ain’t dead yet.


Murray Dawes,
Editor, Pivot Trader