The Two-Legged Stool

Today the S&P 500 is trading back to where it was in December 2014. Volatility is picking up in the U.S. and the “MoMos” are getting hit hard. Internal technicals are horrible too. Many stocks are starting to “breakdown” significantly. Energy, materials, and media entertainment have been weak and biotechnology is just beginning to break lower. Is this the start of a brief decline like we have seen so many times over the last five years or is it something more significant? One thing that we have repeated over and over is that there is very little liquidity in the stock and bond markets when confronted with sustained selling. The HFT program traders will always beat you. On the other hand, with the way this market trades, it wouldn’t surprise me to see new highs this fall despite the current pullback.

The Credit Strategist writes: “A 2% gain in the S&P 500 in July disguised serious deterioration in market internals and a blood bath in commodities and junk bonds. The major stock indices are hovering near their all-time highs courtesy of narrowing leadership by a small number of technology, social media and biotech stocks whose valuations are increasingly reminiscent of the late 1990s. While a small group of stocks was rising and the S&P 500 was recovering its June losses, the commodities complex was collapsing. On July 20th, the Bloomberg Commodities Index hit its lowest level since 2002 as the Nasdaq Composite Index hit new highs. Investors are valuing things they cannot see much more highly than things staring them right in the face. The last time they did that, they lived to regret it.”

China

China’s stock market crash hit a new phase in July as officials began acting on their convictions that high frequency traders are responsible in part for the crash that has sent shares downward by 30% in the last month and a half after stocks rose by 140% in the preceding year.

Global growth is waning and commodities are sending an undeniable signal that trouble lies ahead. Growth in China, which has led the global economic recovery since the financial crisis, is slowing significantly due to problems that reach beyond its plummeting stock markets. Observers have largely ignored the fact that China’s growth has been fueled by an unprecedented debt issuance that can no longer be sustained. China no longer has a functioning stock market. After allowing the market to inflate into an epic bubble, Chinese regulators panicked and shut down normal market mechanisms by outlawing selling by large shareholders, allowing more than half the listed companies to suspend their shares from trading, and threatening short-sellers and journalists. While these measures may temporarily slow the sell-off, they have destroyed the credibility of the market. Communists practicing capitalism?

Oil

Oil has come back down again and may retest the 2015 lows and possibly go lower. Unless some new technology takes hydrocarbons out of the picture as dirt cheap energy, oil is always going to be a massively important commodity. Forbes writes: “We are in the crash phase of oil, but oil will recover; it’s simply a question of when rather than if. Unless the world falls into some kind of new depression, low oil prices will spur a new boom and with that boom demand for oil will soar and when it does so will the price of oil.”

Ambrose Evan-Pritchard began a recent column with “Saudi Arabia may go broke before the US oil industry buckles.” We’ve said in the past that sustained low oil prices will sow the seeds of the next oil boom. We shall see.

U.S. Indices – Year to date as of 8/6/2015

Dow Jones Industrials 17,419 -2.25%
S&P 500 2,083 + 1.21%
Nasdaq 5056 + 6.77%
Crude Oil $44.66 -15.34%
Ceramic OSP Impedance Control
Polymide Hard and Soft Gold Plated Blind/Buried Vias

Have a great summer!

J. Brock Hamilton
August 6, 2015