The Next Meaningful Sell off

Chatter is already making the rounds (from an advisory firm) that a few dovish Fed members are drumming up support for further QE. It is inevitable that such rumours will resurface ahead of the Jackson Hole Fed conference of world central bankers in August.

Equity indices may be selling off after three consecutive rising days, but this week’s shrugging of poor data by equities cannot be ignored. Equities’ resilience to pervasively negative economic data (US and abroad) is taking a life of its own.

Nine-month lows in the US June leading economic indicators index, eight-month lows in US existing home sales and double digit negative reading in the June Philly Fed index—all on the back of the third consecutive monthly decline in US retail sales should be sufficiently negative for equities. Yet indices were still up 2.7-3.0% since Monday.

Whether the rationale is based on the inevitability of further stimulus action from the Fed/ECB, or the avoidance of “horrible scenarios” in US corporate earnings, the resilience of equities cannot be ignored as technicals suggest further gains into the end of summer.

The resurfacing inverse relation between equities and global 10-year yields over the past four weeks backs the aforementioned rationale– Ongoing data weakness has globalised the easing campaign of major central banks, and raising traders’ confidence, thereby driving yields lower and lifting equities higher. US 10-year bond yields have fallen a remarkable 17 bps from the June 22 high of 1.67% to 1.49%.

When’s The Next Meaningful Sell-off? We may not see the next “meaningful” decline in equities until both the manufacturing and services ISMs fall below 50 and extend their fall below 45.0. So far, the services ISM has not yet fallen under 50.0. Even a decline below 50 may prove a 1-time affair before subsequently regaining 50.0–as we saw in January 2007. Thus, only a reading of 47 in both ISMs would be a meaningful red-flag.

The seldom-discussed Leading Economic Indicators index has long been frowned upon by Wall Street as a misleading indicators index, but the chart below show consistency during recessions. Yesterday’s release showed -0.3% in June, the biggest decline in nine months. The LEI index would have to post a monthly decline of 0.6 to 0.7% in order for it to be accompanied with sufficient macroeconomic deterioration and escalating bearishness in equities. The chart shows declines of 0.6%-0.7% in the LEI were consistent with bear markets in equities and recessions. In order to a decline of such magnitude in the LEI and both ISMs under 48-47, this may have to wait until Q4, which is a fitting time for markets to demand additional Fed stimulus to the existing Operation Twist-such as QE. Interestingly, chatter is already making the rounds (from an advisory firm) that a few dovish Fed members are drumming up support for further QE before year-end.