• Weekly Comments for December 21, 2015

    The last two trading days have been very difficult for the markets: the enthusiasm after Yellen's speech melted faster than snow in summer.

    This article contains one of the best explanations of what is happening to the markets: bad credit contagion.

    http://thefelderreport.com/2015/12/1...unk-bond-rout/

    Why contagion? Because the selling is not contained to energy-linked junk bonds. Even XLU and REITs have been under pressure. This probably points to a general fear regarding the debt levels, and with it the sustainability of dividends in these safe havens.





    Just as a small note, I built below a table of companies that offer(ed) elevated dividends.

    The column in pink calculates the difference between the Free Cash flow (the cash available to shareholders after everything else has been paid for) and the dividends. Negative figures indicate that the company is borrowing or is selling MLP units in order to fund the dividends. This of course is not sustainable in an environment where rates increase and bad credit fear is spreading. From this list, a few days ago TOO and TGP cut dividends by 80% and their equity lost more than 40% in one day. Dividends were cut because the companies no longer have access to credit markets. How many REITs and pipelines will have to cut dividends? At least REITs do not distribute more than their FCF, but the Teekay decision is a sign of bad credit contagion: banks do not want to provide funds.



    Another aspect of this contagion can be found in the divergence between the 20DMF and the Cumulative Tick. Why would buyers be interested in small caps and leave the large caps? This could be because many large caps have funded share buybacks through debt and there is a growing aversion to debt. Small caps did not have access to credit and hence could show cleaner balance sheets. Or, put another way, it might be easier to find low caps that are not overextended and display good balance sheets.



    This is also the reason why in the Table below, you can see that for the past two days, IWM has outperformed almost all XLX ETFs (except for XLU.) Also note that XLF is almost at the level of XLE. This also points to a credit issue. Normally, banks should benefit from higher interest rates. Then why are they among the sectors sold the most?



    Even the Mammoth Sector (the 10 strongest stocks on the S&P500) is displaying a negative MF.



    Where do we go from here?

    The S&P500 is now at the lowest section of its envelope. Usually, this is a good spot to buy for a bounce. However, what we have now is a new low due to the failure of the FOMC induced bounce. This probably points to lower prices.

    As of now, the S&P500 is already down 1.73% for the year. For fund managers to be able to get their 20% profit cut, markets would need to retrace this -1.73% loss and more. This means that we would need a stellar Santa Rally from here on. Who or what will trigger such buying? Fund managers will most probably get prepared for 2016 by cleaning dead weight in their portfolio (tax selling season.)



    Below is the Figure that I posted in the daily comment of Friday morning. I wrote: " if the selling today is higher than 1%, then we will continue down the drain. Otherwise, we could possibly buy weakness today for a bounce on Monday." We closed much lower and hence, we should expect more weakness next week.



    I also performed another study today on past occurrences when the 20DMF saw its Money Flow plunge by about 1% for the last two days. In the past two days, the 20DMF dropped by 1.13%. We are in the case of the Pink line, which also points to more weakness.



    Finally, we can see that the markets are not enough oversold for triggering an interesting buy signal. The Figure below shows that we would need more selling to get the "ratio of sectors in a buy wait mode" to higher levels.




    The TED spread also points to interbank tensions. The TED spread is much higher than the level of last August, when China pushed the S&P500 down to $1900.



    Conclusions:

    Contagion can be very fast when fear catches investors. I believe that the Fed will try to talk markets out of their fear early next week or even over the weekend. If this does not work, we will probably break the $1900 level and then the Fed might come out with extraordinary measures. But that would be a "slap in the face" for Yellen. So maybe she will have to wait longer before rescuing the markets with negative rates.