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International Market by Martin Pring’s InterMarket Review (October 2014)

Our Stock Barometer remained unchanged in September. This was due to a negative long-term KST sell signal for the S&P Composite being offset by a drop in the 3-month commercial paper below its 12-month MA. This equity model is now at an 87.5% reading.

Most of the time, equities take their cue from the economy. As long as investors see an expansion continuing, they have a very strong tendency to bid up prices. Chart 12 shows that the ECRI Weekly Leading Indicator remains above its bull market trendline and 12-month MA. However, all three ROCs have violated their uptrends, indicating the leading economic and fi nancial sectors have lost some upside momentum. Experience of the two previous ECRI peaks tells us that a dissipation of upside momentum is usually followed by weakness in the weekly leading indicator itself. The chart therefore warns, but does not yet signal that a reversal in the upward trajectory of the WLI is likely.

Chart 13 compares the ECRI to the S&P Composite. The red vertical lines indicate cyclical peaks in the economic series that were followed by recessions. A comparison of the two series shows that the ECRI WLI usually tops pretty closely to the S&P or alternatively is followed by a trading range prior to the onset of the bear market. The high for the indicator was set back in July, but there has yet not been suffi cient weakness to confi rm that a downtrend is underway; more data is clearly needed. However, it is apparent that the KST has just crossed below its MA. The record shows that in the past, half of those signals have correctly identifi ed an ECRI peak and half have not. The confi rmation we would like to see to tip the evidence from its current 50/50 balance would be a break in trend with a decisive negative 12-month MA crossover and up trendline violation in the ECRI itself. We estimate that number would be in the vicinity of 133 from a current 134.9. Even if that happened, it could well take several months prior to equities themselves peaking. However, were the S&P to drop below its 9-month MA and bull market trendline with a month-end close below 1925, that would strongly suggest the equity market was responding to a challenging economic environment.

Another area to monitor is consumer sentiment as reported by Thomson Reuters/University of Michigan. This series (Chart 14) has been in a secular bear market since 2000. Last month it edged above the down trendline, but not enough for a decisive breakout. Note that the (green) KST in the bottom window is still declining. That is important because it suggests the raw numbers may have a problem violating their down trendline more decisively. You can also see that the Michigan sentiment KST has a consistent record of leading the KST for the ECRI. That means October's sentiment data could be quite critical for the economic outcome. On the one hand, if the data improves, it would result in a decisive secular down trendline violation and a probable KST reversal. Given the leading characteristics of the sentiment numbers, such a breakout would also suggest that the recent negative ECRI KST sell signal could be a false one. On the other hand, weak sentiment numbers would confi rm the secular downtrend, acting as a drag on the recovery. Clearly, things are at a critical juncture.

Long-term Equity Market Indicators

The ratio between the Shiller P/E and the yield on the 20/30-year government bond (Chart 15) is one way of measuring the current rate of return between these two asset classes. Reversals in extreme readings in this series have offered some useful signals of equity market trend reversals in the last 100 years. The red vertical lines fl ag those periods when this valuation technique has initially moved to an excessive level for stocks, equity prices typically fall. Sometimes, such as 1937, the reaction has been simultaneous. At others, such as 1998, the response has been more delayed. This relationship is currently at a record level. It is, of course, free to move even higher, but history shows that the more extreme the reading the greater the risk when values eventually deviate back to the mean. Considering the pallid action of the ECRI WLI discussed earlier, there are certainly grounds for considering equities may be in the early phases of an overall topping out process. Once again, trend trumps everything and until we see some form of long-term trend break such as a 9- or 12-month MA crossover, there is no reason why the elastic cannot be stretched some more.

Chart 16 compounds our concerns. That's because the 12-month ROC of the yield on government 20-year maturities has reversed from a +20% reading. Whenever this has happened in the past, it either followed or preceded an intermediate correction or full-fl edged bear market. Just over half those instances were also associated with a recession. The most recent example developed late last year but has not so far been associated with any kind of equity decline. It could be argued that since short rates, which usually rally with long ones, did not rally in 2013, that last year's signal will turn out to be invalid. However, our more broadly-based master yield, which moves closely with the Barclays Aggregate Bond ETF (AGG) actually rose to a record level last year, telling us that the sharp rise in yields was pretty broadly felt.

Finally, confi dence in the credit markets, or lack thereof, often spills back into the stock market. Chart 17 features three such relationships and all are presently in uptrends. In 2007, they all broke trend along with the S&P and a nasty bear market followed. Their leading characteristics were underscored at the 2009 bottom, when all three diverged positively with the S&P. More recently, new highs in the S&P have not been confi rmed by the Govt/BAA and Janus/T- Bond ratios. That throws up an amber fl ag which will turn to red in the event that all these bull market trendlines are violated. The trendline breaks in the ratios will signal a renewed lack of confi dence in the credit markets. That for the S&P would inform us that equity investors were starting to feel bond investor's pain.

Finally, the weekly NYSE A/D Line using the formula devised by the late, great, Hamilton Bolton, was in gear with the S&P for the bulk of the bull market. However, in recent weeks it has diverged negatively with the S&P and has now violated a key up trendline. Since the line has been touched or approached on seven occasions, it represents major support. The divergence may appear to be insipid because it is so small. However, the tiny 2007 discrepancy reminds us that small divergences can be followed by gigantic fi nancial events.

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