Looking at Tea Leaves

"Cook, Cook, drink your tea.
But save some in the pot for me.
We'll watch the tea leaves in our cup
When our drink is all sipped up.
Happiness or fortune great,
What will our future be?" - From the book, "Afternoon Tea at Pittock Mansion" by R.Z. Berry

Traders spend hours trying to gain an edge over the market and most of it is like looking at tea leaves to dissect and expectation about future market movements.  With the decimation of some of the most prolific momentum stocks in the past few weeks I thought it would be a good to take a look at some market indicators to see what they are telling us if anything.  Now some of this may be relatively technical in nature but that is all part of the education process so bear with me and see if you can make sense of my tea leaves.

First off I took a look at the S&P 500 and while it recently made a new high of 1897.28 on April 4th, it subsequently rolled over.  It did bounce but does not look like it has the momentum to regain its previous high particularly when you look at the Relative Strength Index which is showing short term weakness.  Also given that the Federal Reserve continues to slash its support in $10 billion monthly increments, the catalyst for the market to move higher seems to be gone.  Whether it will actually die or consolidate at this level is still open to debate but on the surface it does not look like it will take out the highs in the coming weeks and in fact may even test the 200 day moving average around 1,800 first.

Looking at the fear gauges of Gold and the VIX it still looks like the market is complacent.  The VIX is a barometer of market fear as it measures the number of put options to call options in a given market.  More put options (an option that bets that the market will fall) shows more concern for future market direction.  A VIX of less than 15 shows complacency while a VIX of over 50 points to high risk.  Right now the VIX is 14 so there is little in the way of panic.  Also while the price of gold seems to have stabilized it is still not showing signs of a full blown recovery in the price.  So by both of these measures the market is not expecting a huge draw down but it is at these times of complacency that the Black Swan appears.

I always follow copper closely as that is a good barometer of global industry and while it has taken a beating in the past few months it is actually showing some signs of strength.  While this strength is very short term in nature and therefore cannot be considered as showing signs of strong global economic growth a recovery has to start somewhere.  So with stock markets looking weak it is always interesting to see a divergence in this commodity from the market movements.  More strength in this price might point to a recover in global trade and that would portend to a stronger economic platform on which markets could base a recovery.

Crude oil recently made a new 52 week high of $104 a barrel and this has had a huge impact on the price of gasoline.  While this price strength can be attributed to stronger demand and therefore stronger economic growth, the impact of this spike in gasoline prices is not encouraging as a sudden spike in inflation would quickly derail any form of recovery.  Consumers are still too cash strapped to handle and extended spike in this price but fortunately the price has quickly fallen to just over $100 a barrel.  I would like to see this below $95 a barrel to ensure that there is not a significant impact to economic growth.

A friend of mine showed me some research on interest rate movements since the 70s.  The study was done to see the impact of rising interest rates on the market returns but what I found most interesting about the study was that from 1970 to 2007 interest rates rose every 5 years or so.  Since 2007 however there really has not been a significant tightening in interest rates and so this recovery is really long in the tooth.  The basic premise is that interest rates have to rise soon but looking at the overall data of low inflation, high unemployment and continued significant (although slowing) stimulus I would expect interest rates to remain low for an extended period.  While this may be good for the market a quick look at Japan shows that even with low interest rates particularly when those are low for an extended period of time there is no guarantee of a continued burgeoning market.  In fact the length of time between raising rates is signalling problems rather than good times so more of the same will have more and more of a negative impact as the magnitude of the problem is truly understood.

Now I could go on with more indicators but the above is a good barometer that the market is really in a quandary right now.  There are no clear signals that point to continued strength or to a total collapse and so I would not be surprised to see the market drift along aimlessly until a new catalyst is found.  What that catalyst is I cannot fathom a guess but I would not think it a time to be overly optimistic and in this type of market caution is often your best friend.