An Alternative Way to Visualize Volatility

One way to look at volatility of stock markets is to look at the standard deviation of returns or a volatility index like the VIX. Another way is to look at the average stock's performance on days when the stock market (in this case the MSCI World Index) is up and on days when it is down. That is precisely what we do in the charts below. What we find is that the average stock's performance on both up market days and down market days has been trending lower since the world markets bottomed in October 2011 (i.e. upside and downside volatility has been trending lower). We also observe that lows in this measure of volatility tend to coincide with intermediate market tops and highs tend to coincide with in intermediate market bottoms. Not rocket science, just a different way to measure how stocks in the aggregate are behaving.

The Company We Keep

Question
What are speculators long right now?

Answer
1) Stocks - from the E-mini S&P500, to the E-mini NASDAQ, to the E-mini Dow, to the E-mini Russell 2000









Question
What are speculators short right now?

Answer
1) Equity Volatility (VIX)

Google briefly tops $1000 for the first time, up 12% so far today

Google beat analyst expectations for 3Q EPS. They reported $10.74 vs expectations $10.34. They also beat revenue expectations by a bit. More importantly to us, technically if Google holds these gains today they will get back on the "right side" of the upward trendline that has been in place for over 2 years.

Is the Euro headed higher?

The Euro surpassed its January high today:

If sustained, it appears to have a good deal of room to move higher:

Short Rates Plunge

In reaction to the deal to avert the debt ceiling, short rates have slammed back down.  The one month bill peaked at 35bps on Tuesday and is back down to 1bp today.

Global Stock Indices Race to New Highs, but Not Confirmed by Measures of Market Breadth

Stocks continue to perform well here, but with little confirmation from breadth measures. We noted the other day here the divergence between lower levels of new 52 week highs and stock indices near all-time highs. Given the rally yesterday, we thought we'd provide a quick mid-week update. We again notice the same divergence between lower levels of new highs (this time over the last 200 days) and rallying stock indices. The divergence is most pronounced in North America, but can be seen in Europe and Asia as well. Rallies to new cyclical highs that take place on dwindling breadth have in the past coincided with intermediate or major tops in stock markets. Note, however, this is not a timing tool because these types of divergences can persist for weeks or months before they are resolved one way or another.

More Positive Data Out of the UK

Today's better than expected Retail Sales data follows a number of other positive releases:

Will the improvements in employment, consumer confidence, house prices, and the Markit manufacturing survey be reflected in next week's GDP release?




Data for Q3 will be updated on Friday, October 25th:

Will the Boom-Bust Barometer Bounce?

The Boom-Bust Barometer (Commodity Prices/Unemployment Claims) has had a very high correlation with stock prices over the past decade. The rise in unemployment claims has driven it lower. We will wait to see if the end of the government shutdown will bring unemployment claims back down. It was only modestly lower this week (-15k).

Advance Auto Parts up 16.5% today but hold on before diving in

Advance Auto Parts (ticker: AAP) gapped up today on the open and finished the day  16.5% higher on the news that it was buying General Parts International, Inc for $2 billion in cash. This phenomenal one day advance, however, doesn't look like it changes the longer-term trend for AAP. The stock should bounce to the top of its nearly 2-year trading range but topping formation still looks to be the most likely configuration for this stock.

The Art of Catching a Falling Knife (or not)

Trading at .2x sales Fujitsu appears relatively cheap, but the stock just continues to go down relative to the MSCI World Index and has recently decisively broken a support level that has been in place since 2012.

Citi Economic Surpise Index & Counter-Cyclicals

Normally cyclical sectors outperform counter-cyclical sectors when the Citigroup Economic Surprise Index is rising and underperform when it is falling.  The Citi Econ Surprise Index is now down since 9/12/13, having fallen over 25 points.  If the relationship between these two variables holds, then either counter-cyclicals start to outperform cyclicals or economic surprises are about to turn back up.

Stock's Correlation with Treasury Bonds is the Single Most Significant Factor Explaining Performance Over the Last 3 Months

We've noted before how we group all 1607 companies in the MSCI World Index into deciles based on various fundamental and market factors, and then observe which factors were significant in explaining performance over various time periods. We call this our Factor Scoring approach and it helps us disaggregate seemingly random market movements into component drivers.

Over the last three months the most significant variable in explaining individual stock performance was each stock's correlation with the 10 year treasury bond, with an R-squared of .91 (an R-squared over .7 is considered statistically significant). In the number two slot was Beta, with an R-squared of .89 and not far behind was each stock's correlation to TIPS yields. This has our attention as we may now be in a rising yield environment in a Post QE World. In such an environment one wants to be exposed to stocks that outperform the market when yields rise.

What is Dr. Copper Telling Us?

We track the relative performance of the cyclical sectors (consumer discretionary, financial, energy, industrial, materials, technology) compared to the counter-cyclical sectors (consumer staples, health care, telecom, utilities) to gain an insight into leadership within the equity markets. Usually copper--the metal with a Ph.D in Economics--moves in synch with the relative outperformance of the cyclicals.  For the last six months, Dr. Copper has NOT been confirming the relative outperformance of the cyclicals.  It should be near $4/lb. to confirm the move in cyclicals.

DAX Closes at All-Time Highs

Germany's DAX index closed at all-time highs on Tuesday:

And, while the rest of the European equity indices have performed well so far this year, few are close to achieving the same milestone:

US Econ Chart of the Day

The NAHB Housing Market Index ticket down from 57 to 55 in October. However, the index has shown a surprisingly strong negative correlation with the Unemployment Rate (Index goes up, Unemployment rate goes down). This relationship would suggest that the unemployment rate continues to fall over the next 18 months.

ZEW Survey

In keeping with the familiar trend among European data releases, Germany appears to be the lone bright spot in an otherwise lackluster survey of economic sentiment:

Diving into the Details of Defensive Growth Underperformance in Recent Months

We've noted before the recent underperformance of "defensive growth" stocks (Health Care and Consumer Staples stocks) so we thought we'd dive into the details to get a better understanding for the drivers of this relatively sudden turn in performance, since these two sectors (and Health Care in particular) have performed admirably this cycle.

We can see in the table below that Health Care and Consumer Staples have on average performed in line with or better than the MSCI World Index over the last four years:


However, over the last three months these two sectors are near the bottom of the list:


From the table below, we can see what drove the performance over the last four years for these sectors. Specifically, it was that the average stock in Health Care and Staples was down less than the overall market on days when the MSCI World Index finished in the red. The fact that our "defensive growth" sectors underperformed cyclical sectors by a wide margin on up stock market days is less relevant, because they lost soo much less than cyclical sectors on down days.



Looking at the last two months, we see a dramatic divergence relative to the last four years. For starters, the average sector performance has been muted on both down and up stock market days (volatility has been suppressed). Secondly, Health Care and Staples have performed about the same on down market days compared the last four years, but have gained a lot less on up stock market days than has been typical. Finally, cyclical sectors like Financials, Materials and Energy have lost much less on down stock market days over the last two months compared the last four years. Stocks in these sectors tend to be highly levered and are generally of lower quality. But as we can see in the below table, Cyclicals have recently traded more like "defensive growth" companies over the last two months than the highly levered, economically sensitive companies that they are.

Teradata Breaks Down

One of the tech high flyers the last few years has been Teradata, who sells software to cloud data centers. Today the target price was cut from $75 to $45 and the stocks is down almost 17%, making it the worst performer in the tech sector.



This drop will accelerate the downtrend that has been in place since last year.  Using our relative strength point and figure charts, we can see the prolonged period of underperformance.  Today's breakdown will be another waterfall decline, taking the stock back toward historic support from 2011.

Gold Stocks Underperforming

Over the last month, gold companies have been among the weakest performeres in the MSCI World Index. On average they are down 9.4% over the last 30 days.



They also top our ranking for the biggest drop in 30 day relative strength.  Using daily returns, we calculate the change in relative strength over the previous 30 days compared to the previous 30 days.

OECD Leading Indicators: Europe accelerating momentum, Asia below trend

The latest data from the OECD leading indicators shows that growth in Europe seems to be gaining momentum (except for Sweden and Switzerland) while in Asia growth is below trend (except for Japan and South Korea). The United States is the only country in North America that is currently experiencing growth above trend according the OECD. Charts to follow:

Chinese Corporate Balance Sheets Continue to Deteriorate

There has been much discussion in recent years of the leverage buildup in the Chinese corporate sector and the problems (or not) that this will (or won't) create, so we thought we'd chime in with some quantitative data and let the reader make his or her own conclusions. The below table is a time series analysis of annual data for non-financial, non-utility CSI 300 constituents. The ratios below are constructed from an aggregation of all individual corporate financial statements. The goal is to see how the listed sector’s balance sheet and profits (in aggregate) have evolved over the last decade. From examining the table below a few things stand out:

1. Operating cash flow margin has fallen by 65% since 2002
2. Total liabilities % of equity has risen by 60%
3. Financial leverage has risen by 26%
4. Total non-financial working capital (which is (Current Accounts-Cash)+(Current Liabilities-Short-term Debt), and used to detect “channel stuffing”) has risen by 105%
5. Net debt is flat (which makes us question the validity of the "Cash" line on Chinese balance sheets)

We are not making a judgment on whether this is sustainable or opining on what kinds of problems this buildup in leverage might create, just observing that certain important measures of profits and leverage have shown persistent deterioration since 2002, and especially since 2009.

Moreover, when comparing the most recent data point across various other Asian EMs it is clear that Chinese companies in aggregate are more levered than their Asian peers, except for Indian companies. The reliance on working capital by Chinese firms to finance sales could be considered high, at least.