Contrarian data point to downside risk
As the first half of the year ends, we are in an up-phase. After the recent sell-off in May and early June, the market internals have started to look better. The S&P 500 bounced smartly off the 200-day moving average and has turned upward.
Yet, if you look at sentiment indicators, a contrarian view would say the pain is not over. Andy Lees writes today:
The first chart overlays the net AAII bull/bear sentiment index, which has rebounded heavily, against the US macro surprise index which remains towards rock bottom at -93.6. As you can see the divergence is the worst since December 2008. (The G10 surprise index is -52.5, Latin America -46.4, Europe -9.30, Japan -62.10, Britain -50.80, APAC, Australia -36.8, although APAC is still +6.70 and China 27.3)
The surprise index measures the divergence between actual data and economists forecasts, and is therefore another form of sentiment or expectations index. Economists are at a near record divergence against the reality of the data, and as the overlay chart shows net bullish market sentiment is also at a near record divergence to how the data is coming out vs expectations.
Perhaps they are right and the economic weakness is just a blip that will pass and the data will rise to meet expectations, but if not there is a big hole between the level of bullishness and the existing reality of the macro data. The second chart shows the VIX index, reflecting "a market estimate of future volatility based on the weighted average of the implied volatilities for a wide range of strikes". The low VIX level suggests a level of complacency totally out of kilter with this level of risk, and at a time when QE2 has come to a conclusion.
Basically, just as the fundamentals are diverging enormously from actual data, bullish sentiment is increasing. That is a seriously bearish contrarian indicator. As for the positive 200-day moving average data I mentioned, Andy writes:
The S&P bounced heavily off its 200 day moving average but the Nasdaq has not yet been able to break back above its 40 year trend line – (trend level today is 2825) – suggesting this is still just a technical bounce and not yet to be trusted, which in the context of near record divergence between data and sentiment & expectations is not a good sign.
The mitigating factors are the recent manufacturing data and the pickup in small business credit. I especially like to see small business with access to and take up of credit because that could mean renewed hiring. The jobless claims numbers are not moving yet though.
Overall, the data are still soft and the surprise index is still saying that earnings estimates will be cut. In my view that means the risk is still to the downside.
Quite frankly I am not surpises at the results for the UK. There has been a spate of big name retail closures this last week indicating that retail sales have been very weak. Banks have also started lay offs but this is all before the expected losses from Greece, which will not harm our banks too much but will increase significantly the risks for Ireland to default which will force many of the remaining banks to seek protection under state control.
Australia looks probably worse with its hugely overvalued property market. Bank losses there could be substantial. Yet they have already sucked in many younger buyers with housing grants so could face significant problems when they are wiped out by a property crash.