• Weekly Comments for May 31, 2016

    Let's first review last week's comment. I stated at that time that rate differentials, the VIX and the US$ pointed to a market bounce.

    http://www.effectivevolume.com/conte...or-May-23-2016

    Now, after four days of bounce, what comes next?

    Equities

    First, we can see that the S&P500 is still high in its 5D envelope. However since the 5D average is rising, another flat day will provide a statistically better long entry.



    The emini does not show much stress.



    The VIX tells us that we will continue higher.



    But for the past days, the 20DMF has been rather weak against a strong Cumulative Tick. All in all, these elements offer a mixed picture. This points to an overwhelming positive and indiscriminate flow of money (probably coming from Japan and Europe because of interest rate differentials) that large investors then use to distribute shares, as evidenced by the weak 20DMF.



    Interest rates and Currencies

    On the interest rate front, the UST/JPB differential is making a bullish flag pattern. I am not sure whether flag patterns have any validity for differentials, though.



    I believe that the G7 meeting has slowed down the BOJ Yen dumping as the Japanese PM does not want to be stigmatized as a currency manipulator. Better let fingers point to China - which is not part of the G7 meetings.

    We can see that rumors about a rate hike in June are pushing the US$ higher and all other currencies lower. The BOJ does not need to force the Yen down anymore: the Fed is doing a pretty good job all by itself.









    Money chasing the largest stocks

    We can see in the figures below that equity money is homing in on the largest caps.

    The Mammoth Sector is shooting up in terms of MF.



    The Large/Small MF analysis on the S&P500 tells us that the "large" group is attracting more money than the "small" group.



    The Non-S&P500 stocks seem to be stalling.



    The Nirp triggered liquidity flow

    This article published by Wolfstreet explains the Nirp triggered liquidity flow.

    http://wolfstreet.com/2016/05/26/neg...easury-yields/

    The extinction of retail investors

    I find the figure below rather interesting to read in the context of liquidity provided by QE and now by Nirp.

    If we accept the premise that retail investors make up the majority of ETF investors while funds account for the majority of direct stock purchases, then the ratio of S&P500 volume to volume traded by the three largest ETFs should tell us much about the effect of liquidity injections.

    We can see that before 2008, the ratio was trending down. This means that retail investors were increasingly participating in the markets through ETFs.

    However, starting from 2009 we see a change. Liquidity was provided whenever markets were about to break after an initial drop. Most retail investors were slow to react and did not repurchase their ETF positions sold during the pullback. The figure below probably tells us that between 60% and 70% of all retail investors have moved to the sidelines, waiting for a crash.

    The figure also tells us that money coming either from the Fed or from Japan has been buying US equities directly without going through ETFs. (Direct ownership is better than going through a third party.)



    It is interesting to see that the ratio reversals have corresponded to price reversals.




    The figure below is built using a 50-day average instead of a 5-day average. Note that the ratio broke above its ascending trendline. This tells us that much liquidity is flowing into US equities. Since the reversal coincides with the BOJ Nirp, then it is clear that this money comes from Japan.



    NYSE Margin

    The NYSE margin figure is also interesting to analyze. This figure dates from last month, but it shows that even though margin decreased, equities continued to gain. This also points to external liquidity that is stronger than the margin decrease.



    Excess Reserves

    Finally, as of two days ago excess reserves were not increasing. This is a good indication that the TBTF are not pulling money out of the markets.



    Conclusions:

    If the Fed raises interest rates, equities will probably stay supported both by the interest rates differentials and by the excess reverses.

    What could push equities lower?

    1. If the Fed does not raise rates and we have an unexpected Brexit decision in the following days
    2. If the Fed raises rates but within the following days provides higher rates on excess reserves
    3. If the Fed lowers rates but keeps the current level of interest on excess reserves
    4. If the BOJ reverses its Nirp policy (This is the least likely outcome.)

    Question: Since the current equities push is due mostly to a flow of outside money that is based on rate differentials, if the Fed decides to do nothing in June, won't the money flow reverse out of US assets after an initial algo push higher?

    My position is now rather balanced, with long QLD and short individual stocks that are under pressure (Very negative EV patterns during the bounce.)

    The "in May go away" well-known investment saying will be replaced in just a few days by the more bullish "buy in June Presidential election years."

    Tuesday will also be the last day of May, which is the final window dressing day.
    Comments 1 Comment
    1. PeterR's Avatar
      Quote Originally Posted by ; View Post
      "This points to an overwhelming positive and indiscriminate flow of money (probably coming from Japan and Europe because of interest rate differentials) that large investors then use to distribute shares, as evidenced by the weak 20DMF."

      Brett Steenbarger points to this metric that seems to imply the same lack of (US? ) institutional buying participation.
      Historically this metric led SP500 if it was in the top quartile. But currently it is very low, despite the advance in price.



      (NYSE uptick/downtick ratio. I don't know how he calculates this and from what source. I was unable to reproduce it with the market internals I have.)

      http://traderfeed.blogspot.de/2016/0...n-matters.html

      I still think the institutional funds are overly pessimistic and hence not smart money.
      I think the US economy is relative strong but confidence is relative low, so more upside potential.