Mind the Gap – shares diverge from earnings

Mind the Gap – shares diverge from earnings

In the past ten trading days, the Dow has swung in a tight trading range between the 18,050 and 18,250 levels. There have been two clear attempts at breaking down past the 18,050 support zone, but both failed.  That was my slightly preferred option. This morning, it is now making an assault on the upper resistance level.  Will it succeed in breaking through?

There is little doubt that most MSM headlines have emphasised the bearish case for stocks as my trusty HI has indicated.  They have pointed out that US company earnings continue to decline quarter after quarter, yet stocks remain elevated.  Then there is the ‘uncertainty’ created by the shock Brexit referendum vote that still reverberates around financial markets.

Here is the awful truth – that S&P earnings are heading south while shares are going north

isn’t that an impressive divergence?  I guess all of the investing textbooks that contains the iron-clad principle that stocks follow earnings must now be burned.

I have alluded to the gloom-and-doom headlines generated about Deutsche Bank’s well-publicised problems.  It is fair to say that investors are currently nervous and several well-known gurus have emerged recently to advise taking some profits at the current nosebleed levels of P/E.

And waiting in the wings is the US elections in only two weeks time.  There is bound to be added volatility going into November 8th!

Also, a recent DSI reading shows bullish sentiment has fallen from the super-confident 90% level in July to the current uncertainty 40% as the Dow has dipped from the 18,500 level to today’s 18,250.  Now that is a very small decline for such a large dip in bullish sentiment.  To me, it demonstrates that the market is more resilient than I had imagined.

This is what I mean – here is the 4-hour chart

I have an A-B-C down to the 18000 support C wave low and provided the market can push strongly above the 18,250 resistance, we will be in a purple third wave up.  The key test will be at the 18325 level at the meeting of the blue and pink trendlnes in a ‘Chinese Hat’ (see text, pp 59 – 60, 135).

If the market can punch above that, the move will be ferocious as many bears will be forced to cover.  And word that the Fed will not move to increase the Fed Funds rate (US data turning less than rosy?) could set the shorts running.

This promises to be an exciting two weeks for US stocks.  Yesterday, Nasdaq – the speculator’s darling index – pushed up into new all-time highs.


UK Housing prices – are they running out of gas?

The perennial topic at dinner parties (or so I’m told) is the price of housing, especially in London and South-East.  They continue to rise inexorably and received wisdom has it that there is too much demand and not enough supply at current prices, so they must keep rising to curtail demand.

With the UK population expected to continue its giddy rate of growth (Brexit or not), isn’t it obvious that prices must continue to rise?

One of the enablers of rocketing prices is that mortgage rates are a fraction of what they were in, say, the 1980s and 1990s.   That makes the repayments ‘affordable’ even at these elevated price levels.  After all, for most younger buyers, all they are really interested in is the amount of monthly repayments.  They know prices are rising, so they figure they had better do it now rather than wait – if they can.

In fact, this impulse is the very same as that driving financial markets ever higher.  It is partly based on confidence in the assumption of future price growth that translates into high bullish sentiment.

But as I have pointed out recently, long-term interest rates are now on the rise with US  10-yr Treasury yields rising from 1.38% in July to today’s 1.75%.  This does not sound like much, but it is a near 30% increase.  That is massive – and mortgage rates usually follow these yield trends.

So the potential is there for a rise in UK mortgage rates and a sharp increase in repayments.  This will very likely put pressure on house prices.

Here is a fascinating chart of UK average house prices since the 1960s

From near-zero (or so it seems) in 1966, to £200k today, the ascent is in a clear Elliott five up impulsive wave with wave 3 long and strong.  We are now in the final fifth wave up.

The chart is telling us that time is running out on the post-war house price explosion.  Of course, there could be several years left to go before the actual top, but I would not be putting money on the same rate of growth over the next fifty years!

Already the rate of price increases is falling hard and London is showing much indigestion with asking prices for the top areas reported being slashed by tens of percent.  The next couple of years could see average prices back down to the Wave 4 low at around £150k.

The consensus is that interest rates will stay lower for longer, but we know what happens to consensus, don’t we?

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