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3 of our favorite indicators of risk continue to signal “risk off”.

In analyzing risk in the market, we predominantly rely on quantitative models that we’ve developed over the years. However, there are other indicators that we’ve found helpful in instructing us as to the “risk-on” vs. “risk-off” situation in the market. These indicators can provide helpful clues as to the potential strength or durability of market rallies. The last time we updated them in a post was in mid-August. Our conclusion then:

“Taking stock of the combination of these 3 “risk-on/risk-off” measures, we find adequate reason for some concern. There are certainly enough positives in the market to maintain moderate long exposure to stocks. Furthermore, the broad market would appear to be setting up for a breakout to new highs. However, given the status of these risk indicators, an aggressive play on the potential breakout is probably not warranted. Furthermore, should the broad market break out, and these risk measures fail to follow along, it could be an indication of a likely failed, or temporary, breakout.”

Indeed, the broad stock market would break out to new highs in the final days of August — and immediately fail from there. The large-cap indices were able to hold up for about another month before they too failed to maintain their breakout levels. The continued deterioration in the risk indicators into those late September-early October highs further convinced us of the likely fallibility of the breakout and the weakness that would follow.

In our present case, we take stock of the 3 risk indicators once again in an attempt to determine the amount of risk remaining in the selloff and the potential for a turnaround.

High-Beta Vs. Low-Volatility (Status: RISK OFF)

One such risk-on indicator can be found in the “high-beta” area of the market – especially in its behavior relative to “low-volatility” stocks. To track these groups, we use the Invesco S&P 500 High Beta ETF (SPHB) and the Invesco S&P 500 Low Volatility ETF (SPLV). We have found that typically when the ratio of SPHB to SPLV performance is rising (e.g., 2012-2015, 2016-2018), it is an indication of “risk-on” – and constructive for the prospects of the overall market. When the ratio turns lower (e.g., 2011, 2015-2016), we’ve found the opposite message to be true, i.e., “risk-off”. This chart illustrates that idea.

Back in August, we first noticed the developing breakdown in the SPHB:SPLV ratio, and the potentially negative implications for the market. The ratio would continue to lead the stock market decline lower into the late October correction low.

So what is it signaling now? After a temporary bounce off of the October low, the ratio is once gain setting new correction — and multi-year — lows. Those hoping to see an imminent end to the correction would rather have the ratio positively diverging vs. its October low to indicate a decreasing risk situation. However, the fact that the ratio is again dropping to new lows is a sign of continued elevated risk in the market.

Small-Cap Pure Value (Status: RISK OFF)

When it comes to market “styles” (e.g., small, mid, large-cap and growth vs. value), the small-cap pure value style traditionally has the highest beta. And like the “high-beta” stock segment mentioned above, the S&P 600 Small-Cap Pure Value Index (SPSPV) typically leads the way in a legitimate risk-on market rally — and lower in a risk-off move. For example, the SPSPV led the way higher during the beginning of rallies starting in January and November 2016, August 2017 and February of this year. We have seen the opposite situation since August.

In our August post, we noted preliminary signs that the SPSPV was beginning to lag badly behind most of the other style segments. As it happens, the index would top out within days and begin a steady descent, even as the large-caps made a series of further new highs. This was another red flag for us regarding risk. Obviously, in hindsight, the caution was warranted as a broad market correction unfolded.

So what about now? One of the best signs that stocks were not “off to the races” following the late October low was the anemic bounce in the SPSPV as it failed to retrace even 38.2% of the initial correction decline. And presently, we find little reason to believe that risk has been adequately wrung out of the market in the near-term. That’s because the SPSPV was one of the first indices to actually eclipse the initial October correction low yesterday. When risk levels are finally appropriate for stocks to form a low and begin rallying on a more durable basis again, look for this index to display more resilience than this.

High Yield Bonds (Status: RISK OFF)

The last indicator we’ll look at is the high yield bond market. We are certainly not the only ones to look to the high yield bond market, appropriately in our view, for clues on risk appetite. As high yield represents the riskiest of all bonds, the space actually trades in concert with equities much of the time. Thus, when high yield bonds are rallying, it is indicative of risk-taking, which generally includes a rallying stock market. When the high yield space turns down, it can be a sign of risk aversion — and a cautionary sign for stocks.

In August, we noted that the iShares High Yield Corporate Bond ETF (HYG) was running into some potential resistance on its chart (on an unadjusted basis). Indeed, the fund would be within 0.25% of its eventual rally high. Its behavior following would raise alarm bells as the HYG dropped to a new 52-week low at the initial correction low in late October.

Things have not improved since. The fund undercut its October low a week ago and has been declining since. It is now trading at multi-year lows. That is not indicative of a situation whereby risk has adequately been wrung out of the market and investors can begin aggressively buying back in.

Aggregate Conclusion: RISK OFF

While the stock market correction has certainly wrung out some of the excess risk that we were warning about in late summer, it does not appear to be enough to yet lay the foundation for an intermediate-term low and a new durable rally. The status of the 3 key risk indicators above each indicate a continued elevated level of risk in the stock market at this time. Therefore, our focus would not yet be on significantly increasing equity exposure in anticipation of an impending successful re-test of the October low. Rather, we will continue to be more focused in the near-term on reducing exposure, or hedging into any near-term market strength.

*  *  *

For updates on these risk indicators as well as market levels, timing and investment selection, continue to monitor our Daily Strategy Session videos.

If you are interested in an “all-access” pass to our research and investment moves, we invite you to further check out The Lyons Share. FYI, we are currently holding our BLACK FRIDAY SALE — our BIGGEST SALE OF THE YEAR. So considering the discounted cost and the current treacherous market climate, there has never been a better time to reap the benefits of our risk-managed approach. Thanks for reading!

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WTI has rallied since last night’s API-reported surprise crude draw, but remains drastically lower even from yesterday’s highs.

President Trump’s tweet thanks Saudi Arabia for lower oil prices one day after announcing the U.S. won’t let the murder of a journalist jeopardize relations with the kingdom, slowed the momentum a little.

“Another week of inventory builds would most certainly push oil prices down further, as market concerns over waning demand growth intensify,” says Cailin Birch, global economist at The Economist Intelligence Unit

API

• Crude -1.545mm

• Cushing +398k – 9th week in a row

• Gasoline +706k

• Distillates -1.823mm – 9th week in a row

DOE

• Crude +4.85mm (+3.45mm exp) – 9th week in a row

• Cushing -116k

• Gasoline -1.295mm (+100k exp)

• Distillates -77k – 9th week in a row

Reversing the gains from API’s reported draw, DOE reported a bigger than expected crude build – the 9th weekly build in a row. Distillate inventories drewdown for the ninth week in a row and Cushing’s streak of rising stocks ended…

Production was unchanged at record highs on the week.

The kneejerk reaction was to erase the post-API gains…back to a $53 handle…

 

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October’s final UMich consumer sentiment data disappointed and slipped from September’s data, with current conditions and expectations both declining.

However, perhaps the most critical element of the survey is that expectations for rates to increase (relative to expectations that rates will fall going forward), have reached a historical threshold that has typically preceded a contrarian recessionary impulse.

As UMich explains:

Interest rate expectations have always traced the outlines of economic cycles. As expansions lengthened, more consumers would expect interest rate increases, pushing the series to cyclical lows; then consumers would suddenly reverse course, lowering expectations just as downturns were about to commence (see the chart above). Note that recession dating lags by about one year, meaning that expected declines in rates are recorded about one year before the official announcement. While there is no reason to anticipate a sudden change in expectations in the months ahead, consumers have begun to resist rising interest rates on purchases of housing and vehicles.

Hopefully this time the Fed will manage interest rates to avoid hitting the threshold that causes widespread postponement as has been true in the past.

Unfortunately, it seems the impact has already begun as buying conditions in aggregate are trending lower…

Favorable vehicle buying attitudes remained at the same five-year low recorded last month. Consumers made as many favorable as unfavorable references to prices, well below the positive balance in last November’s survey, and net references to low interest rates on vehicle purchases were mentioned by one-third of last year’s total. Favorable home buying conditions remained at depressed levels, even as the proportion citing attractive pricing inched upward. The market is dominated by mortgage rates, with favorable references falling by more than half compared with last November. Overall, the net declines will act to reduce the number of homes and vehicle sales in the year ahead.

 

 

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Despite a modestly better than expected 1.4% MoM rise (after September’s 3.4% slump), existing home sales slumped 5.1% year-over-year – the biggest drop since 2014.

A blip higher in SAAR…

 

Regionally, The West is suffering the most…

• Existing-home sales in the Northeast increased 1.5% to an annual rate of 690,000, 6.8% below a year ago. The median price in the Northeast was $280,900, up 3.0% from October 2017.

• In the Midwest, existing-home sales declined 0.8% from last month to an annual rate of 1.27 million in October, down 3.1% from a year ago. The median price in the Midwest was $197,000, up 2.4% from last year.

• Existing-home sales in the South rose 1.9% to an annual rate of 2.15 million in October, down 2.3% from last year. The median price was $221,600, up 3.8% from a year ago.

• Existing-home sales in the West grew 2.8% to an annual rate of 1.11 million in October, 11.2% below a year ago. The median price in the West was $382,900, up 1.9% from October 2017.

The median existing-home price for all housing types in October was $255,400, up 3.8 percent from October 2017 ($246,000). October’s price increase marks the 80th straight month of year-over-year gains.

And NAR agrees with President Trump in asking for rate cuts:

“Rising interest rates and increasing home prices continue to suppress the rate of first-time homebuyers. Home sales could further decline before stabilizing. The Federal Reserve should, therefore, re-evaluate its monetary policy of tightening credit, especially in light of softening inflationary pressures, to help ease the financial burden on potential first-time buyers and assure a slump in the market causes no lasting damage to the economy,” says Yun.

So is Trump right?

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Following Vice President Pence trading barbs with China’s President Xi Jinping over the ongoing trade war during back-to-back speeches at an an unusually tense Asia-Pacific Economic Cooperation summit in Papua New Guinea over the weekend, a US Navy aircraft carrier strike group has entered Hong Kong’s port early Wednesday in what appears a sign of easing military tensions. 

Beijing authorities granting the application for the port visit of the Navy aircraft carrier and three accompanying battleships comes less than two months after China previously denied a similar visit by a US warship.

A number of reports are interpreting the move as an attempt to ease tensions prior to Presidents Xi Jinping and Trump’s expected meeting at next week’s G-20 summit in Argentina. Significantly it also comes two days after the US Air Force flew two B-52 bombers over a contested area of the South China Sea where China has laid claim to international waters based on its military build-up on a chain of man-made and other islands. 

The strike group includes the carrier USS Ronald Reagan, guided-missile cruiser USS Chancellorsville, and guided-missile destroyers USS Benfold and USS Curtis Wilbur, which were all cleared to dock, confirmed by the the Hong Kong Maritime Department.

In October the amphibious assault ship USS Wasp was refused entry into semi autonomous Hong Kong’s port, and prior to that in 2016 a US carrier strike group was also barred from docking — both instances due to increased tensions over waters in the South China Sea. 

Tensions were more recently on full display when in early October Chinese destroyers came within a dangerous 45 yards of the USS Decatur while the latter was engaged in a “freedom of navigation” operation near Chinese-claimed islands.

Meanwhile last Saturday the head of the US Indo-Pacific Command, Adm. Phil Davidson, condemned what he described as a campaign of military intimidation in the South China Sea in a speech before the Halifax International Security Forum in Nova Scotia. 

“They’re now violating the sovereignty of every other nation’s ability to fly, sail, and operate in accordance with international law,” Davidson told the forum.

Come November 30 at the G-20 summit it’s anyone’s guess over whether Trump and Xi will take the opportunity of face-to-face private talks to agree to climb down from escalatory trade war policies or publicly ratchet up mutual condemnations further.

Top White House economic adviser Larry Kudlow’s dire predictions issued in a Tuesday statement, saying he expects a direct confrontation over trade, suggests the latter is the more likely scenario. “It will come to a head at the G20, I think that’s the key point,” Kudlow told White House reporters. 

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House Republicans will hear testimony on December 5 from the prosecutor appointed by Attorney General Jeff Sessions to investigate allegations of wrongdoing by the Clinton Foundation, according to Rep. Mark Meadows (R-NC).

Meadows – chairman of the House Oversight Subcommittee on Government Operations, told The Hill that it’s time to “circle back” to former Utah Attorney General John Huber’s probe with the Justice Department into whether the Clinton Foundation engaged in improper activities, reports The Hill. 

“Mr. [John] Huber with the Department of Justice and the FBI has been having an investigation – at least part of his task was to look at the Clinton Foundation and what may or may not have happened as it relates to improper activity with that charitable foundation, so we’ve set a hearing date for December the 5th.,” Meadows told Hill.TV on Wednesday. 

Meadows says the questions will include whether any tax-exempt proceeds were used for personal gain and whether the Foundation adhered to IRS laws. 

Sessions appointed Huber last year to work in tandem with the Justice Department to look into conservative claims of misconduct at the FBI and review several issues surrounding the Clintons. This includes Hillary Clinton’s ties to a Russian nuclear agency and concerns about the Clinton Foundation.

Huber’s work has remained shrouded in mystery. The White House has released little information about Huber’s assignment other than Session’s address to Congress saying his appointed should address concerns raised by Republicans. –The Hill

According to a report by the Dallas Observer last November,  the Clinton Foundation has been under investigation by the IRS since July, 2016.

Meadows says that it’s time for Huber to update Congress concerning his findings, and “expects him to be one of the witnesses at the hearing,” per The Hill. Additionally Meadows said that his committee is trying to secure testimonies from whistleblowers who can provide more information about potential wrongdoing surrounding the Clinton Foundation. 

“We’re just now starting to work with a couple of whistleblowers that would indicate that there is a great probability, of significant improper activity that’s happening in and around the Clinton Foundation,” he added. 

The Clinton Foundation – also under FBI investigation out of the Arkansas field office, has denied any wrongdoing.

Launched in January, the Arkansas FBI probe, is focused on pay-for-play schemes and tax code violations, according to The Hill at the time, citing law enforcement officials and a witness who wishes to remain anonymous. 

The officials, who spoke only on condition of anonymity, said the probe is examining whether the Clintons promised or performed any policy favors in return for largesse to their charitable efforts or whether donors made commitments of donations in hopes of securing government outcomes.

The probe may also examine whether any tax-exempt assets were converted for personal or political use and whether the Foundation complied with applicable tax laws, the officials said. –The Hill

The witness who was interviewed by Little Rock FBI agents said that questions focused on “government decisions and discussions of donations to Clinton entities during the time Hillary Clinton led President Obama’s State Department,” and that the agents were “extremely professional and unquestionably thorough.”

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Three weeks ago we reported that in the first nail to its investment grade coffin, GE had found itself completely shut out of the Commercial Paper market when Moody’s downgraded its senior unsecured rating to Baa1, from A2, and downgraded the short-term rating to P-2, from P-1, making future sales of CP impossible. So, in lieu of CP access, GE said it would replace that funding with a net $40.8 billion of available credit facilities committed from banks. Or, as we explained “GE will now use its revolver, which carries a higher interest rate, to fund what it previously achieved using CP.”

This transition in GE’s reliance from commercial paper to revolver is not just a problem for GE, however, which now faces higher funding costs and encumbered assets: with the industrial conglomerate’s business and operations deteriorating rapidly, GE has become a major headache for America’s largest banks almost overnight.

As Bloomberg reports, the five biggest Wall Street firms have committed to lending at least $3.5 billion each to GE even as the industrial giant is facing rising concerns about its viability and the sustainability of its debt.

As we reported on Halloween, GE has almost $41 billion in credit lines it can draw from, and according to Bloomberg, when fully tapped, GE’s two main credit facilities would rank as the largest loans to any U.S. company that go beyond next year.

The good news for GE, is that so far it has only used about $2 billion of the available credit by the end of the third quarter, leaving itself ample room to pull more if necessary. That’s also the bad news for the big banks who are contractually obligated to provide the bank with an additional $39 billion in liquidity.

Indeed, companies typically draw down heavily on their credit lines when facing funding shortfalls. Earlier this month, investment grade-rated, yet extremely troubled California utility PG&E fully used its credit facility, sending its stock plunging even as its investors worried the company might lose its investment-grade credit rating or face liability related to wildfires ravaging the state.

Bloomberg notes as much, saying that from GE’s perspective, the unused credit is a crucial backstop as analysts voice concerns about the risk of a funding shortage.

Chief Executive Officer Larry Culp has been selling assets to raise cash and is under pressure to raise more through a stock offering. The untapped credit “gives us a foundation” as the firm takes steps to reshape itself and ultimately reduce its borrowings, he told CNBC this month.

From the banks’ perspective things are not nearly quite as rosy as the possibility of a draw-down by a borrower shut out of other funding sources poses serious liquidity risks, “including default if the company ultimately proves unable to manage its obligations.”

Meanwhile, the cost of GE default protection has soared with CDS now trading at 250bps, up from 50bps 2 months ago, signaling not only the possibility of further cuts to GE’s credit rating and higher costs for new borrowings, but – unthinkably – a default. As a reminder, GE was downgraded by the two biggest rating firms last month, ending up three grades above junk; more downgrades are imminent.

Bloomberg has some more details on GE’s revolvers, which the company divided into three categories at the end of September. The main one includes a $19.8 billion credit line from six banks, which expires in 2020. Then there’s a $20 billion backup facility from 36 banks expiring in 2021.

The third group is a collection of credit lines arranged individually with seven banks, expiring between February and May of next year. While GE doesn’t identify the three dozen lenders in the backup facility or specify how they are splitting their commitment. JPMorgan is among members of that group, so is Wells Fargo & Co., which isn’t one of the lenders named in the first line.

Such commitments can make up an outsize chunk of a bank’s portfolio. Morgan Stanley’s share of the first GE facility amounted to 6 percent of its investment-grade lending commitments at the end of September. At Goldman Sachs Group Inc., it was 4 percent of the bank’s high-grade book.

As one would expect, executives of banks who are now on the hook for billions are desperate to sound confident about the company’s prospects: “I’m not concerned about GE’s credit at all,” Morgan Stanley CEO James Gorman said Tuesday in an interview on Bloomberg Television. “The market over-worries. GE is a fantastic institution, they have tremendous ability to restructure.”

Of course, Gorman knows that he is right only as long as GE retains its investment grade rating; once it is junked – and the great and inevitable “fallen angel” avalanche begins all bets are off. Still, there are limits to banks’ exposure. According to Bloomberg, GE’s filings show there are offset provisions for firms participating in both syndicates, potentially preventing the company from tapping the same lenders twice. Also, banks hedge themselves against losses from big borrowers by buying credit derivatives that act as insurance.

Well, one look at GE’s CDS shows that banks are growing more “confident” by the day that that $41 billion committed to GE, is money they will never see again…

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With Goldman Sachs cutting its price target on Apple shares for the third time this month while the consumer-tech giant’s shares sink into bear-market territory, more signs of slowing iPhone demand have emerged Wednesday morning to hammer the shares of Apple suppliers, and perhaps Apple itself.

According to Bloomberg, which cited an internal memo, Foxconn Technology Group, the company’s largest assembler of its phones, is planning to cut some 20 billion yuan ($2.9 billion) in expenses next year following a “very difficult and competitive year” – the latest sign that Apple suppliers are bracing for a sustained slowdown in orders that could have a lasting impact on their bottom line. Some 6 billion yuan ($900 million) worth of cuts will affect Foxconn’s iPhone business. The company’s spending in the past 12 months is about NT$206 billion ($6.7 billion).

The memo said the company would review performance of managers with an annual compensation of more than $150,000, along with a planned 3 billion yuan ($450 million) reduction in expenses at Foxconn Industrial Internet Co., Foxconn’s offshoot in Shanghai.

“The review being carried out by our team this year is no different than similar exercises carried out in past years to ensure that we enter into each new year with teams and budgets that are aligned with the current and anticipated needs of our customers, our global operations and the market and economic challenges of the next year or two,” Foxconn said in an emailed statement in response to Bloomberg queries.

Reports about Foxconn’s cuts followed a WSJ report published Tuesday about cuts at three Apple suppliers. Earlier this month, four suppliers on three continents slashed their revenue forecasts, citing weak demand for Apple’s latest batch of iPhones. This in turn triggered a blowup in shares of Lumentum and other suppliers that infected the entire tech space.

Fortunately for Foxconn, Apple isn’t its only customer: The company assembles everything from iPhones and laptop computers to Sony Corp. PlayStations at factories around the world. It’s even building a factory in Wisconsin that President Trump has heralded as a sign of jobs flowing back to the US (though the company hopes to staff it with either Chinese nationals or robots). 

With trade tensions adding to global uncertainty and threatening to upset supply change, suppliers of smartphone components are struggling with an inevitable trend: After years of torrid growth, smartphone sales have finally plateaued. Companies like Apple are adjusting to this by charging more per unit and offering more paid services like digital storage. But suppliers thrive on volume, which means they will have little recourse as sales fall.

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