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

The Stock Barometer remained bullish in October at an 83.3% reading. A review of its components shows that baring an unexpected sharp decline in equity prices, it is unlikely to go bearish soon.

Stocks anticipate economic developments the vast majority of the time by declining ahead of recessions and slowdowns and advancing prior to recoveries taking hold. The 1927 and 2001 periods were notable exceptions, where correct knowledge of the economic outcome would have led to losses. That is because the market totally ignored the 1926/7 recession and moved higher. It also extended its bear market in 2002 after the economy had bottomed. Since its inception in the mid-1960's the ECRI Weekly Leading Indicator is a series that has had a reasonably good track record of calling recessions, slowdowns and recoveries. In this respect, Chart 10 shows the indicator has clearly lost upside momentum as all three oscillators have experienced up trendline violations, in a similar manner, to the previous cycle.

Chart 11 shows the weekly picture, where once again, all three KSTs are dropping. Most signifi cant is the fact that the indicator itself has violated its 2009/14 recovery up trendline and experienced a negative 65-week EMA crossover. If the indicator remains below these technical benchmarks, a slowdown or recession will likely begin to take hold sometime in the next few months.

However, other leading indicators such as the Chemical Activity Barometer (CAB) (Chart 12) and the Conference Board's Leading Index have not confi rmed this weakness. As a result, we need to be very careful in drawing overly pessimistic conclusions until the consensus of the data refl ect greater weakness. Since 1954, a negative 12-month MA crossover by the CAB has signaled every recession. The indicator has only fallen marginally from its recovery peak, so a negative crossover has not yet happened. The fl attish action by the three ROCs though, is a warning that leading economic sectors may be delicately balanced. This loss of upside economic momentum is being felt by the relationship between equities and bonds.

For instance, Chart 13 shows the ratio between them has tentatively completed and broken down from a top formation and crossed below its 12-month MA. The action is not dissimilar to that which developed at the 2000 and 2007 equity market peaks. All of which suggest that bonds have begun a period of out-performing equities. It also refl ects a loss of upside momentum in the economy because if equity market participants were expecting greater profi ts, they would surely be bidding up stocks against bonds. Charts 14 and 15 take us a step further by comparing the long-term KST momentum of equities with those of bonds.

Normally in Stage II, which is what our barometers are currently signaling, equities are rising sharply as they anticipate the next recovery. Since the market had previously been discounting the recession, the long-term KST is typically reversing from a depressed level. The bond KST, of course, is also advancing because of the defl ationary environment. Those "classic" Stage II periods have been fl agged with the green arrows in Charts 14 and 15.

Occasionally, a different pattern develops as bonds experience the normal KST reversal from a sub-zero level. This time though, the stock KST peaks from an overextended position on the upside. This combination is very unusual and typically bearish because the extended equity KST indicates the market has already discounted the recovery. On the other hand, the bullish bond KST hints the rise in rates that caused it to decline in the fi rst place is now starting to adversely affect the economy. Therefore, the rolling over action of the stock KST signals that equity investors are aware of this change in economic status.

These periods have been fl agged with double dashed red arrows for recessions. In 1929, it was a depression of course, but the 1952, 1957, 1982 and 2007 situations were followed by recessions. The current peaking action of the S&P KST has been colored in gray because we do not know the recession/slowdown outlook. Optimists may choose to interpret the color as silver as they hope for a possible KST reversal to the upside and a consequent negation of the current signal!

Chart 16 shows the number of bearish advisors as published by investorsintelligence.com. It is plotted inversely so that movements correspond with those of equity prices themselves. Sometimes the (red) moving average of this data offers pretty timely sell signals when it reverses from an elevated level above the upper horizontal line. Examples developed in 2007 and 2010. However, several signals in the last couple of years have had a relatively muted effect, so we cannot say that every signal will be followed by a serious decline. Even so, it seems that if the up trendline in the raw data is violated, we couldsee something on the lines of the sell-offs thatfollowed three previous trendline breaks. These situations have been fl agged with the small brown arrows.

Long-term Sector Momentum

Charts 17 and 18 show the absolute (as opposed to relative) long-term KSTs for early leading (defensive) and lagging (earnings driven/resource based) sectors, respectively. There are two objectives in presenting these chart arrangements. First, they offer a guide for the primary trend momentum position for specifi c sectors. Second, they act as a cross check for the specifi c stage being signaled by the barometers. For example, under defl ationary conditions, we would expect to see early cycle leaders in a better position to lead the market higher and vice versa. "Better" in this case does not necessarily mean that these sectors are in a (bullish) rising mode. It could be that they were far more advanced than lagging sectors in the corrective process and would therefore be in a better position to trigger that positive reversal at the appropriate time.

Right now, the one thing that stands out is that virtually all sectors are experiencing a declining KST from above the equilibrium level. Chart 17 shows that two of the early leaders, namely Utilities and REITS, are already bullish, whereas the rest are still progressing through their corrective phase. Nevertheless, early leaders, taken as a group, are certainly in a better position to reverse to the upside than their earnings-driven counterparts.

As for the earnings-driven lagging sectors most have only just started to roll over, which is consistent with the recent sell signal triggered by the Infl ation Barometer.

Since virtually all of the sectors and industry groups are experiencing declining KSTs, there are precious few that are currently in a position to lead the market higher. That will be a problem unless more of the early cycle leaders can join the utilities and REITS with a rising trajectory.

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