On the fence about rates?

This week as markets continue to levitate higher, a couple of reports came across my desk that I wanted to point out to my readers.

First from, Tom McClellan Editor, The McClellan Market Report

A-D Line’s Troubling Divergence

Now we are seeing another bearish divergence that has developed at the right end of the chart, and so far this one has not yet been rehabilitated. It still could be, but for the moment it is a problem for the market to have higher price highs that are still unconfirmed by the A-D Line. And this comes in tandem with last weeks article about a similar looking divergence in the behavior of the stocks that make up the Nasdaq 100 Index.

Watching the A-D Line is important because it can give us hints about problems with financial market liquidity ahead of those problems affecting the big cap stocks. Everyone knows that indices like the SP500 are dominated by a handful of really big capitalization stocks. But the smaller ones fight for liquidity in the same market, and they are often the first ones to suffer when liquidity starts to dry up.

It is the same principle as the canaries that used to be used in coal mines a couple of centuries ago. These small birds were more sensitive to the presence of toxic gases, and so if the canaries keeled over then the big burly coal miners needed to get themselves out of the mine before they succombed.

The first analysts to study the A-D data in depth were Leonard Ayres and James Hughes, of the Cleveland Trust Company. They wondered starting in 1926 what it meant to have more or fewer stocks going up or down each day, and so they started gathering the data. If only chartists could have known about the concept of an A-D Line divergence back in the late 1920s, perhaps there could have been better warnings ahead of the 1929 crash.

We saw A-D Line divergences that were important in the 2000s, although not as much as the 1929 example. At the big October 2007 price top, the A-D Line was already in a downtrend, having topped out 4 months before. That was a pretty ominous warning of trouble, and it was right.

In the current time frame, it is still possible that the A-D numbers could improve, and produce a rehabilitated divergence. That is possible, and I will be on the lookout for it. For now, though, it is giving us a big warning of trouble, saying that in spite of the Fed still buying $120 billion a month of bonds, liquidity is starting to dry up. Just imagine what will happen if/when the Fed starts its taper.

Then from, Bill Gross:

The Institute of International Finance in a recent advisory hit the nail on the head – not that they’re any better at forecasting than any other trade association. In an August 12th note the IIF’s Robin Brooks questioned ballooning debt levels and how much debt governments could sell to markets at current low yields. In the U.S., the IIF paper found that in the past year the Fed absorbed 60% of net issuance through quantitative easing with the balance purchased elsewhere. How willing, therefore, will private markets be to absorb this future 60% in mid-2022 and beyond? Perhaps if inflation comes back to the 2%+ target by then, a “tantrum” can be avoided, but how many more fiscal spending programs can we afford without paying for it with higher interest rates?

I’m thinking 2% 10-year Treasuries over the next 12 months. Through the benefit of my aging mathematical gymnastics, that equates to a 4%-5% price loss and a negative total return of 2.5%- 3%. Cash has been trash for a long time but there are now new contenders for the investment garbage can. Intermediate to long-term bond funds are in that trash receptacle for sure, but will stocks follow? Earnings growth had better be double-digit-plus or else they could join the garbage truck. And then there’s the now recent Afghanistan fallout, and the incessant push of global warming that few investors seem to care about unless there’s a new solar IPO to run up on the first day. There are other problems but I best keep it simple.