Given, there’s a lot of moving parts here and gas prices tend to work with a lag from the faster declines in world oil markets, but the boost to the economy is not being felt in the here and now.  So we’ll wait and see.  If gas prices are sustained at lower levels then you’ll see the price at the pump drop much further, but for now the big drop in oil prices is not immediately translating into the big boost to the economy that everyone keeps saying it is…..

“Panic” resurfaces. Admittedly, markets rarely get that “cataclysmic crescendo of capitulation” to call for buying stocks, but proprietary measures such as the Panic/Euphoria Model now are intimating that upside opportunity has re-emerged. Meetings with institutional investors do not anecdotally demonstrate that people are “freaked out,” but the sharp decline over the past six weeks has caused significant deterioration of sentiment (even amongst credit investors). Other metrics still are not providing the requisite buy inflection such that a more positive view for stocks is appropriate but that nuance does not imply a willingness to grow long bull horns yet.”

“For some perspective on all-important long-term interest rates, today’s chart illustrates the 112-year trend of the 10-year Treasury bond yield (thick blue line). Escalating concerns over Europe in addition to a struggling global economy have encouraged investors, institutions and governments alike to move a portion of their investment dollars to the relative safety of the US. This has resulted in a significant decline of the 10-year Treasury bond yield. In fact, the 10-year yield has declined a fairly dramatic 340 basis points (i.e. 3.4%) since the peak of the credit bubble. This decline has brought the 10-year Treasury bond yield to a 112-year low. The decline of the 10-year Treasury bond yield has been significant enough to bring the 10-year yield near resistance of what is a 26-year downtrend channel.”

 

Bullish sentiment is near a two-year low in the latest AAII Sentiment Survey, while bearish sentiment has spiked by 17.5 percentage points over the past two weeks.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 1.8 percentage points to 23.6%. This is the lowest level of optimism recorded in the survey since August 26, 2010. This is also the seventh consecutive week that bearish sentiment has been below its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 2.1 percentage points to 30.4%. This is the just the second time in the past eight weeks that neutral sentiment has been below its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 3.9 percentage points to 46.0%. This is the highest level of pessimism recorded by the survey since September 29, 2011. This is also the sixth consecutive week that bearish sentiment has been above its historical average of 30%.

The difference between bullish and bearish sentiment, the bull-bear spread, widened to -22.4 points. This is the most negative the bull-bear spread has been since September 22, 2011.

Bullish sentiment is unusually low, but it would have to fall below 18% to be considered extraordinarily low (two standard deviations below average). Similarly, bearish sentiment above 50% or a bull-bear spread below -29 points would be more correlated with market reversals. Last year, bearish sentiment topped 46% three times during August and September.

The two-week decline in stock prices, renewed uncertainty about Europe, and signs of slower U.S. economic growth have combined to fray the nerves of individual investors. The 17.5 percentage point rise in bearish sentiment over the past two weeks shows that many investors are second-guessing their prior short-term outlooks.

This week’s special question asked AAII members if they are concerned that a repeat of last year’s market correction could occur this summer. The overwhelming majority of respondents said that yes, they are concerned that a correction will occur. Most of them cited Europe as the primary problem. The minority of respondents who were not concerned either thought that the negative headlines were mostly priced in or are planning to buy stocks on any summer decline.

Here is a sampling of the responses:

• “I feel like the issues in Greece, France and Spain are going to cause an economic downturn here in the United States.”
• “Yes, my primary concern is Europe and its unsettling influence on the U.S. markets.”
• “Yes, I’m concerned because of the European banking crisis, particularly Spain and the possibility of a Greek default.”
• “I’m concerned about it, but I think there’s good a chance that the market is recovering, albeit with a bumpy ride.”
• “No, I’m not concerned because if it does recur like last year, August—September could become a likely timeframe to buy into stocks.”

This week’s AAII Sentiment Survey results:

• Bullish: 23.6%, down 1.8 percentage points
• Neutral: 30.4%, down 2.1 percentage points
• Bearish: 46.0%, up 3.9 percentage points\

Historical averages:

• Bullish: 39%
• Neutral: 31%
• Bearish: 30%

The AAII Sentiment Survey has been conducted weekly since July 1987 and asks AAII members whether they think stock prices will rise, remain essentially flat, or fall over the next six months. The survey period runs from Thursday (12:01 a.m.) to Wednesday (11:59 p.m.) The survey and its results are available online at:http://www.aaii.com/sentimentsurvey

Charles Rotblut. CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.

“We now have sufficient CAI coverage to aggregate the country-level series into a PPP-weighted Global CAI Aggregate. Like the output of our Global PMI-Implied Growth Model, the Global CAI is an approximation of the current sequential rate of global growth. Our Global CAI is currently tracking at 4.1%, nearly a full percentage point higher than our PMI-based estimate and also above our and consensus forecasts. This divergence may reflect two things: (i) our Asia CAI data is currently only available through March and (ii) European national business surveys have significantly outperformed PMIs recently.”

Source: Goldman Sachs

The CRB commodities index broke through the apparent support level discussed earlier. Commodities continue to be pressured by the global slowdown and Eurozone driven market stress. Recent dollar strength also added momentum to the selloff.

CRB Commodities Index

With the correction in the commodities markets, US dollar inflation expectations are down sharply.  The 2×2 (two-year forward) TIPS implied inflation measure went from some 2.25% in March to under 1.5% now. As long as Europe continues to flare up and commodities are under pressure, inflation expectations should stay subdued.

2×2 TIPS implied forward inflation expectation

• Data released by the National Energy Administration (NEA) on May 14 show that China’s electricity consumption totaled 389.9 billion kWh in April, up 3.7% year-on-year, 3.3 ppts lower than the growth number in March. Power consumption by industrial enterprises amounted to 285.8 billion kWh, up 3.6% year-on-year.
• Decline of power consumption growth shows a continuous down trend in economic growth.
• In the first four months this year, the average utilization time of power generating facilities in China was 1,480 hours, down 48 hours year-on-year. Hydroelectric power generating facilities’ time in use was 728 hours, down 72 hours year-on-year; and the time figure for thermal power generating facilities was 1,705 hours, down 30 hours year-on-year.
• Related Data: Total Electricity Consumption, Primary Industry Electricity Consumption, Secondary Industry Electricity Consumption, The Tertiary Industry Electricity Consumption, Urban and Rural Residents Electricity Consumption, Industrial Electricity Consumption.

“The target is marked by the burning LOH.”

When I was an reconnaissance helicopter pilot in the Army many years ago, that was a popular saying that was passed down by the more experienced pilots, some of whom had flown during the Vietnam War.  It was meant to convey our own frailty, and the foolishness of being too eager about finding the enemy’s location.

LOH back then stood for Light Observation Helicopter, either a Hughes OH-6 Cayuse or a Bell OH-58.  It was pronounced as “loach”.  They were 4-seat commercial helicopters that were bought by the Army and adapted for use in scouting for enemy forces.  A pilot had little more than his eyes and his wits as weapons, and the .040″ aluminum skin and Plexiglas windows were not much protection from enemy fire.  The idea was to fly low, using the terrain for cover and concealment, and try to find the enemy so that fighter planes or attack helicopters could be called in to deliver ordinance on the enemy’s position.

But given the fact that enemy soldiers are usually not stupid, and don’t want to be spotted, often the first indication that a pilot had located the enemy’s position was that he was taking fire from the enemy.  A lot of them got shot down.  So then another helicopter crew would step in to radio the fast movers and guide them into the target.  The fighter pilots would acknowledge that call, and the existence of enemy fire in the area, and then ask:

“Roger, how is the target marked?”  The question was about the possible use of colored smoke, landmarks, or other features that can be seen while zooming in at 500 MPH.

And the answer would be, “The target is marked by the burning LOH.”

There is a corollary to this in the financial markets.  Quite often at the end of a big price move, we learn about a big institution blowing up because they did not think that the trade would go so far against them.  The 2006 case of Amaranth Advisors would be a classic example, with its bankruptcy in late 2006 marking the bottom for natural gas prices ahead of the big commodity bubble in 2008.  There were several portfolios that blew up at the top of that bubble.

In this week’s chart, I have labeled several notable news events that served as markers of important turns for T-Bond prices.  Back in 1994, Orange County, California went bankrupt because its treasurer, Robert Citron, had overextended his bets the wrong way in the bond market.  That bankruptcy marked the bottom for the big price decline.  Orange County was the burning LOH.

In late 1998, the money management firm Long Term Capital Management (LTCM) famously made huge bets on T-Bonds that were based on the limits of how far price moves had historically gone in the past.  And the market taught them a lesson about how trends can persist longer than one can stay solvent.  The Federal Reserve had to intervene, lining up several major banks to help take apart LTCM’s positions and keep it from cascading into a bigger problem.  LTCM’s collapse was the burning LOH for that up move.

More recently, the collapses of Bear Stearns, Lehman Brothers, and MF Global each coincided with peaks in bond prices.  Each was the burning LOH for its particular moment in history.

So now this week, we find out that J.P. Morgan Chase (NYSE:JPM) has suffered a $2 billion loss on financial derivative bets that went bad.  And this news comes as T-Bond prices are once again getting back up to the price levels seen at last year’s MF Global collapse.  The implication is that the news of JPM’s big loss is serving as the “burning LOH” of this current time frame, and the news arrives just as the stock market is about at the end of the corrective period suggested by both our eurodollar COT leading indication and the Presidential Cycle Pattern.  Subscribers to our twice monthly newsletter and our Daily Edition have been watching the current stock market correction unfold pretty much right on schedule relative to those models, and now we have a portfolio blowup to help mark the beginning of the end of that corrective process.

Related Charts

Chart In Focus Archive

The CRB commodity index has been a good relative indicator of global risk appetite. During stressed conditions the expectations for global growth declines, forcing commodities lower. Oil prices for example respond to the upside during periods of economic growth. But they also move up due to regional tensions such as those associated with Iran. The CRB index on the other hand tends to respond mostly to growth expectations only.

The index peaked in the first half of 2011, driven by QE2. In the past 9 months the index has found a support level at about 293. This is the third time during the period that we’ve approached this level, and it looks as though we are again going to bounce up. But it tells us that this period of financial stress driven by Europe and the US slowdown is similar to what we experienced in September and December of last year. This will be one of the key indicators to watch for early signs of financial stress conditions going forward.

CRB commodity index

Scotty Barber at Reuters provides a nice chart:

“Citigroup’s G10 economic surprise index has taken a nosedive in the last couple of weeks”