There’s so much to talk about as the market heads toward a very dark and cold July, I hardly know where to start.
Perhaps for that reason, I’ll defer to a very memorable and valuable quote from none other than Ernest Hemingway. In A Moveable Feast he wrote…
Sometimes when I was starting a new story and I could not get it going, I would sit in front of the fire and squeeze the peel of the little oranges into the edge of the flame and watch the sputter of blue that they made. I would stand and look out over the roofs of Paris and think, “Do not worry. You have always written before and you will write now. All you have to do is write one true sentence. Write the truest sentence that you know.” So finally I would write one true sentence, and then go on from there.
So I thought that I would start off this article today with one true thing, regarding the technical picture, and that is…
The S&P 500 Today Is on the Verge of Breaking Its Uptrend from the May 3 Low
You can see that in the top half of this chart. Meanwhile, momentum, at the bottom of the chart, is slinking along in barely positive territory. It never confirmed the new interim highs in the uptrend by making new highs itself. Instead, it has formed what we technicians call a negative divergence.
Now, negative divergences often do resolve to the upside. But when momentum turns down from a weak position, it invariably leads to a big decline in prices. We’re on the doorstep of such a change right here. It all hinges on whether the market holds here or breaks the uptrend over the next few days.
In fact, it may have already broken by the time you read this. So there’s no time to waste. Here’s why.
At the bottom of the chart you see the idealized cycle periods. The 13 week, 6-7 week, and 4 week cycles all align to the downside starting around July 10. That doesn’t guarantee a decline. It just signals that the cycle wave patterns will be most propitious for a decline at that time.
Prior to that these short term cycle alignments are mixed. The market could churn along in a trading range or it may not. The cycles do not align for concurrent strength. But this kind of conflicting cyclicality is not a recipe for a rally. And it would not preclude structural technical weakness from setting in (If you are interested in the heavy duty technical stuff, you can follow me in the Wall Street Examiner Pro Trader).
July is also the month where the Fed is scheduled to increase its balance sheet bloodletting from the current $30 billion to $40 billion per month. That will hurt. So will the $95 billion in net new Treasury supply that the TBAC says will settle in July.
I’ve covered the coming July collapse in detail in this report, so make sure you’ve read it to get all the details.
The Treasury Lost $23 Billion In Monthly Revenue. That Means The Markets Have A Supply Problem
Falling tax revenue due to the tax cut and increased spending due to the BBA – officially the Bipartisan Budget Act, but which I call the Budget Busting Agreement – ensure that the Federal government will be crushing the market with an average of $100 billion per month in new supply as far as the eye can see.
There’s no question that Federal Tax Collections are falling. As I covered in the Wall Street Examiner Pro Trader Federal Revenues update this week, May tax collections fell 9.9% year over year. April was up thanks to a windfall in individual non withheld taxes, probably due to investors culling capital gains back in February. But February, the first month where withholding tax tables were adjusted to the new tax rates, saw a 9.4% decline in total tax collections – and March, a 2.5% decline.
May saw an 11.6% drop in withheld taxes, a 50.6% drop in corporate income tax collections, and a 9.8% drop in excise taxes, on which there were no significant changes in the new tax law. That all added up to a year to year drop of $23 billion in Federal revenues.
Compare that to January, before the tax cuts and BBA. Year to year that month saw a $17 billion gain in total Federal revenues. That’s a $40 billion revenue loss between January and March. The government must make up that loss with borrowing. With the Fed not printing the money to absorb that, somebody has to sell something to raise the cash to pay for that. So money gets sucked out of the markets.
That is showing up first and foremost as tightening money markets. The interest rate on 4 week T-bills perfectly illustrates what is going on. They are rising relentlessly month after month, regardless of whether or not the Fed rubber stamps the tightening market that month.
The tax cuts and increased spending are supposed to act as economic stimulus, but apparently they are not. That was most apparent in social security tax collections in May, which belied the bogus strength in the May jobs data. The tax data showed otherwise. Social security tax collections were up just 1.7% year over year. That’s less than the wage inflation rate that is now approaching 3%. There were no cuts in social security taxes in the new tax law. The tax data therefore says that there aren’t more jobs.
And lest we think that this is a one-off, the 1.7% gain there comes on the heels of just a 2% gain in April and a similar performance in March. The increase in social security taxes was below the wage inflation rate in all three months. So there’s something fishy about the jobs data.
We can also see the weakening of the majority of consumers in America via gasoline consumption. May saw a year to year decline. That’s continues a skid that has been going on since March. Soaring gas prices have forced the majority, who are living paycheck to paycheck, to cut back on consumption.
But real data doesn’t matter to the Fed or to Wall Street pundits. Individual estimated non withheld taxes, that is the taxes of the self-employed and stock owners reaping capital gains, rose 25% in May. May isn’t a tax due month, but April was, and non withheld taxes were up 27% year to year. Strength at the top of the economic pyramid will continue to skew the manipulated economic data higher, and the Fed will continue to tighten.
But the social security tax collections show that the base of the pyramid continues to be hollowed out in this Tale of Two Economies. In the long run, it’s very bearish. But for now, the partiers linger after the punchbowl has been pulled.
The Chinese Selloff Could Foreshadow a Dip in Your Portfolios
Meanwhile, last week I pointed out that China’s stock market was on the verge of a technical breakdown that would signal that money is also tightening there. Policy and reporting from China are unreliable, so I prefer to look at the effect rather than try and analyze unreliable data about the cause.
And what infects China, infects the world. We saw that in June 2013, in what was reported to be a “taper tantrum” in the US. In reality China had tightened and margin calls went out around the world because Chinese investors literally face a possible death penalty if they sell their Chinese stocks into a sharply declining market there. So they sell whatever foreign assets they can to raise cash and meet those margin calls. And the easiest and quickest place to raise cash is always Wall Street.
Well, this week, China’s stock market did, in fact, break down. I warned that this would be a warning that the US would be next. So, we have been warned.
I have also warned you not to chase the recent rally. July looks like the month where the market should start to break down. That doesn’t mean that it will, but the risk is high and growing. I would be out of this market, and for more aggressive traders I would be shorting the SPY, and even buying limited amounts of puts on it. I’d look at puts just in the money (just below the strike price), with about 5-6 weeks to go until expiration, to catch this next wave down.
The odds may be in our favor now, but limit your purchases to what you are willing to lose. If I am wrong about July, these options can go to zero. But if I’m right they can return multiples of what you have bet.
In addition, you can look at our ideas here, or check out Shah Gilani’s put play research and recommendations in Zenith Trading Circle.