Tension On The Tape

The financial markets spent the first quarter performing their version of “Much Ado About Nothing”. After stumbling out of the gate with a 7% decline over the first twenty-two trading sessions of the new year, the Dow Industrials spent most of February and March backing and filling before a sprint to the finish line left the venerable index just shy of its all-time record closing high. And therein lies the rub….

 The Standard and Poor’s 500 was able to surpass its old closing high and the Dow Transports were able to post a new high as well. The Industrials’ inability to follow suit has, for the nonce at least, set up the possibility of a sell signal from the Dow Theory.

 A substantial majority of forecasters has been calling for higher interest rates in 2014 but the market itself paid no heed as prices edged up and yields declined a bit over the course of the quarter. This occurred despite all of the ballyhoo about the Fed’s “tapering” of its monthly open market purchases of government and mortgage-backed bonds. Even the news that global debt surpassed the $100 trillion mark (billions and billions sold!) was largely ignored. In fact, investors’ (or should it be speculators’?) demand for lower quality debt continued unabated. The lessons about reaching for yield from 2007-2009 have been largely forgotten.

Commodity markets presented a varying picture as agriculture and livestock prices rose while the metals were mixed. Copper, the metal with the PhD in Economics, sold off for the period as a whole but was able to end with a rally. Energy prices were up across the board.

The latter no doubt was due to a prolonged stretch of unseasonably cold weather that fueled demand for energy products while serving to reduce economic activity overall. When conditions improved in the second half of the quarter, there was a snap-back in the general economy. Production fell in January by 0.3% but jumped 0.6% in February. Unemployment claims moved up to 348,000 during the January deep freeze but fell back to 311,000 at the end of March. Finally, the commodity price index dropped to 278 on January 21 before rallying to close near 305 on March 31.

In the sporting news, despite serious concerns about disruptions from protests and/or terrorist activity, the Winter Olympics came off with barely a glitch. Well, there was the problem in the opening ceremonies when one of the Olympic rings refused to open properly on cue. We hope that whoever was responsible for the mishap has plenty of warm clothing as we understand that it can get rather chilly in Siberia.

 While the Olympiad was spared disruption, the ongoing crisis in Ukraine is drawing attention (and tension) from all corners of the globe. Russia’s provocative occupation of the Crimea has led to a potentially explosive situation.

 In other news, there are reports that North Korea is developing a smart phone (better late than never?). We are wondering if it will have an app for launch codes. They do so love to shoot missiles into the ocean.

 Our last bit of miscellany for this issue is that researchers are said to be working on a wristwatch that purportedly will be able to predict one’s lifespan by analyzing clues contained in the epithelium of one’s skin. Apparently the epithelium knows all (please don’t tell the NSA).

 “Tension on the tape” is an expression oft employed by the late Ed Hart, an analyst for the former Financial News Network back in the day. Mr. Hart would opine that such a situation obtained whenever the market was “burning and churning” like it did during the first quarter – a lot of minor fluctuations within a generally flat trend. The suggestion was that, when the tension reached sufficient potency, it would propel the market out of the trading range in one direction or the other. We employ it here because the stock market’s inability to sustain its early downtrend coupled with its failure to break out to new highs in convincing fashion last quarter has left many pondering the old question, “How now, Dow Jones?”

In our last missive we noted that the stock market was exhibiting some of the signs of a bubble top. January’s sell-off let some of the air out of said bubble and, after the market bounced off support in February, it looked like all systems were “go” for a move to new highs. As noted heretofore, a number of stock indices were able to move to higher ground. As they did so, however, fewer and fewer individual stocks were making new highs – definitely a sign of market halitosis (bad breadth).

 Furthermore, as the rally proceeded, most of the indicators of bullish sentiment reached even higher levels than were in evidence at the end of December. Sentiment indicators are contrarian – the idea is that if the overwhelming majority is bullish, they have already acted on that sentiment and there isn’t enough “fuel” left to push the market higher. Hence, the market literally ran out of gas.

 After last year’s strong gains, it could be that we are in for an extended period of backing and filling. At this juncture it is difficult to tell if this is the pause that refreshes after a long bull run from the lows in 2009 or a case of exhaustion to be followed by a sizable correction.

 The Fed has started to ease back on monetary stimulus on the margin. In past cycles that has been a clue to start heading for the exits. Yet at present the central bank really isn’t making credit scarce so much as it is merely mopping up some of the excess liquidity left over from what was by far the greatest monetary expansion in history.

 Furthermore, economic growth appears to be picking up somewhat. Commodity prices, like stock prices, are pushing against upside resistance. If the commodities can break through, then stocks may well follow.

 On the other side of the ledger, the financial stocks have been lagging the general market for some time (see chart below). That typically leads to trouble for the general market but the lead time can be long and variable.

Instead of trying to pick the trend, perhaps the best play now is to go long volatility. In this scenario one makes money no matter in which direction the break of the trading range occurs. There are, of course, no free lunches so one can lose money if the trading range extends. As Ed Hart was also fond of saying, “We shall only know in the fullness of time.”


Weaver C. Barksdale, CFA