While the talking mannequins and “analysts” on cable business shows dissected, discussed and debated yesterday’s FOMC statement, the S&P 500 gave up more than it gained yesterday after the report from the FOMC about the interest rate nudge hit the tape. Meanwhile the Philly Fed manufacturing index dropped to its lowest level since February 2013, as new orders tanked to a three-year low and future expectations folded.
The reality that the U.S. economy is in a full-mode decline was reinforced by the continued drop in the price of oil, which fell and closed below $35/barrel and by a flattening of the yield curve, where the interest rate spread between the 2yr and 30yr Treasuries declined to its narrowest level since early April 2014. The price of oil is now below the lows it hit in early 2009. The flattening of the yield curve reflects the market’s anticipation that the economy is headed for recession, if not already in one. In absence of extreme Central Bank intervention, the shape of the yield curve historically has been a remarkably accurate economic indicator.
While the S&P 500 has been trending laterally since late 2014. It’s been slowly “rolling over.” Yesterday’s move popped the S&P 500 back above its 50 day moving average. But today it dropped right back below both the 50 and 200 dma’s. The stock market as represented by the S&P 500 is more overvalued now relative to its underlying fundamentals than at any time in history. (click on image to enlarge). As you can see, the stock graphically appears as if it is about to roll down a steep hill.
Another indicator which illustrates the enormous downside risk to the stock market is the correlation between the S&P 500 and the CRB commodity index. Over very long periods of time, the direction of the SPX and the CRB is typically highly correlated. The graph to the left, which goes back 21 years, shows this correlative relationship. The graph on the left (click to enlarge) is on a monthly scale and goes back to 1994. As you can see, the divergence between the SPX and the CRB is more extreme now than it was leading up to the peak of the internet/tech bubble. We know what happened to the stock market in early 2000. I would suggest that there is a very high probability that the S&P 500 and the CRB will re-correlate and that the move which forces this event will cause a more severe decline than was experienced in 2000-2002 and in 2008-2009.
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