There are important rating changes this week.
Last Friday (9/9/2016) was a big day for the
markets. Concerns about declining bond prices and the potential threats that
rising interest rates pose to global economic growth weighed heavily on the
markets. Both stock and bond markets declined. An added concern was North
Korea’s test of a nuclear weapon. For the week, the DJ Industrial Index
finished -2.2%, and most of that loss occurred on Friday (-2.1%).
Bloomberg News has a good summary (click here) and analyst
comments (here) of the day’s market moves and what might be behind them. The article indicates that the equity market
declined in response to concerns that bond prices are likely to fall from this
point on. Jeffrey Gundlach, a well-respected bond manager, announced on
Thursday that bond prices have peaked and are likely to decline from this time
forward. The logic is that bond prices move lower because of higher interest rates.
As interest rates move higher, stock prices decline because much of the
increase in stock prices over the last several years has been attributed to
extremely low interest rates. If interest rates move higher from here, stocks
will find less support, and both stock and bond prices will fall.
The Market Resilience Index Ratings confirm his
view of the bond market. The table below shows the ratings for the US 10y bond
futures (TY1) and the DJ Industrial Average. The ratings are scaled from 0 to
3, with 0 being the most vulnerable and 3 being the most resilient. The ratings
reflect the number of positive values of three Market Resilience Indexes:
Macro, Exceptional Macro, and Micro.
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Important inflection points occur when a market gains
or loses its Exceptional Macro MRI (see the tab above for an explanation of the MRI ratings). The dates of the loss
of this key MRI are shown by heavy borders.
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7/15/2016
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7/22/2016
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7/29/2016
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8/5/2016
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8/12/2016
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8/19/2016
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8/26/2016
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9/2/2016
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9/9/2016
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9/16/2016
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Bond Market
Rating (TY1)
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3
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2
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2
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2
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2
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2
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2
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1
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1
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1
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DJ Industrial Average
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3
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3
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3
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3
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3
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3
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2
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2
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2
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1
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The MRI ratings for bonds are consistent with Mr.
Gundlach’s assessment. He also states that when rates do rise (and bond prices fall), they will do so
gradually. This too is supported by the MRI levels, at least for the near term. The MRI levels tend to be
cyclical, and the shortest-cycle MRI is the Micro MRI. For bond prices (TY1), the level this week is
low. The current level is lower than 90% of the weekly levels since March 1983. Since it is toward the lower extreme, it is becoming more likely that the Micro MRI will turn positive over the next few weeks. When it does, the rating for the bond market (TY1) will move to 2 from 1,
indicating a higher level of resilience for bond prices. Clearly, Gundlach
makes longer-term forecasts than I am doing here; the Focused 15 Investing approach is responsive to current market conditions as they unfold and does make long term forecasts.
The changes in the MRI ratings for the DJ
Industrial Average have moved more quickly over the recent weeks. The loss of
the Exceptional Macro MRI occurred just this week. This is a important event and one
that we have been watching for over the last several weeks. The loss of this important MRI may last a few weeks or quite a bit longer.
Regardless, we can expect the next few weeks to be a rough ride. The Micro
MRI for the DJIA, which ceased to be positive on 8/26/2016, is at a moderate
level and is likely to move lower. Since 1919, the Micro MRI has been higher in
55% of the weeks and lower in 45%. Thus,
there is still downside to prices and vulnerability on a short-term basis. Without the Exceptional Macro MRI, declines are likely to be more pronounced.
The Focused 15 Investing model portfolios have
been slightly defensive for several weeks and are more defensive this week.
These exposures are driven by the MRI ratings discussed here plus additional MRI-related measures.
The S&P Goldman Sachs Commodity index is now
rated 3, up from 2 the prior week. This move was expected. Commodities have
been beaten down over many months (with little regard to their MRI ratings) and
are have been rebounding. There may be price declines, but declines are not likely to
be dramatic or long lasting given their current ratings. However, commodity prices could move against
their resilience ratings as they did in 2015 given stress in the stock and bond
markets.
Emerging Market stocks also experienced losses
last week. The MRI ratings on this market are more positive. It still has the
important Exceptional Macro MRI, and the Micro MRI is at a high level. Only 5%
of the weeks since 1989 have higher levels, so there may be near-term price
declines and this may add to market stress.
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7/15/2016
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7/22/2016
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7/29/2016
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8/5/2016
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8/12/2016
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8/19/2016
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8/26/2016
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9/2/2016
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9/9/2016
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9/16/2016
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MSCI Emerging Market Stocks
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3
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3
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3
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3
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3
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3
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3
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2
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2
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2
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At the moment, these declines are likely to be
moderated by the two other positive MRIs that give the rating of 2 (discussed briefly below). Qualitatively,
these markets may be supported by higher commodity prices, as emerging market countries tend to be
commodity exporters. Should a global stress
get very high, emerging markets may move in concert with major markets.
Taking A Step Back
While all this sounds quite pessimistic, the resilience of markets globally
appears stronger at this time than it did in the period March 2015 through
March of 2016. Stock markets in the UK,
Europe and Emerging Markets are all more resilient at this time than in the
earlier period. Unfortunately, Japanese
stocks still appear quite vulnerable.
While these circumstances can change over a period of a few weeks, markets appear able to withstand a moderate level of anxiety about growth at this
time.
And this makes sense. The central banks will raise rates to rise
back to more normal levels as economic growth takes hold.
Additional Asset Class Detail
US Bonds
With a rating of 1 on the resilience scale, the US 10y Treasury yield
is moderately vulnerable to declines. I expect this condition to remain in
place for the next few weeks. The Micro Market Resilience Index suggests
resilience, while the Macro and Exceptional Macro continue to suggest
vulnerability.
The US 10y Treasury Futures (TY1) is rated 1,
based on the Macro MRI. It lost the Exceptional Macro MRI for the week of
9/2/2016. I expect the Micro MRI to be present over the next week or so.
US high-yield bonds continue to be rated 3, or highly resilient. All
else being equal, high-yield bond prices will tend to rise. The rating may drop
over the next few weeks to 2, when the Micro MRI ceases to be positive.
Developed Market Stocks
US industrial stocks, as represented by the Dow Jones Industrial
Average, dropped to a rating of 1 this week. It lost the Exceptional Macro MRI
this week, which is a notable shift. While this shift may be temporary, Focused
15 Investing portfolios are more defensive this week.
UK stocks are rated 2 this week, down from 3 as expected.
European stock prices have a rating of 2. At the moment, it appears
that this rating will remain in place for a few weeks.
Commodities
Overall, commodity prices are resilient with a rating of 3, up from 2
last week.
The S&P Goldman Sachs Commodity Index represents a basket of
commodities, with a high weighting in crude oil. Crude oil (not shown in
graphic above) continues to have a rating of 3. Please note that crude is a volatile
asset and can differ meaningfully week to week from its MRI ratings. Over long
periods of time, however, the ratings result in profitable trades.
Gold has a rating of 2, moderately resilient. There may be near-term
price softness, but the Macro and Exceptional Macro MRI continue to be
positive, and prices are likely to be resilient mid-to-longer term.
Emerging Markets
Emerging market stock and bond prices are rated moderately resilient.
At the moment, this appears to be a temporary breather because the Macro and
Exceptional Macro Market Resilience Indexes are both positive.
Chinese stocks, as represented by the Shanghai Composite, have a
rating of 0, which suggests vulnerability to declines.
Currencies
The Dollar index, DXY, is rated 0 and is vulnerable to declines. This
is noteworthy considering concerns about rising rates in the US, which would
typically lead to a stronger USD. We will be watching this conflicting signal.
The Euro is rated 3, but may this rating may be short lived; we may
see a rating of 2 in the next week or so. Regardless, EURUSD may continue to
appreciate because of the positive Macro and Exceptional Macro ratings.
GBP is rated 2, which means it is moderately resilient. This is a new
rating and suggests a positive shift – it was rated 0 just a month ago.
