Situation: unchanged

The ECB action come largely as expected. The Pavlovian reaction to buy stocks lasted a day. On Friday, US stocks were already on going down. And why not: QE in EU makes the dollar stronger thus weakening US corporate experts and lowering their overseas profits.

Looking past the day to day fluctuations, the situation remains unchanged:

1. Leading and concurrent indicators are down.

2. The credit spread is increasing:

3. Safety is the word in stock markets. The breath is deteriorating.

Unless the picture changes these dynamics change, the market is heading down.

A, B, or C

The divergence between credit spread and stock market has been widely noted in financial media. Often weakening credit spread signals loss of risk appetite and impending correction in stocks. But not always. Note area A in the figure above. Credit market signaled steep decline that did not materialize. Usually, the stock market and credit market decline simultaneously as in B above. And then we have C where credit spread preceded steep decline in stocks.

So is the current decline A, B, or C? B is ruled out by comparison (stocks and credit do not move in sync). It does not look like A either: the credit spread increase has been prolonged and sustained lasting over 6 months. And this happens in the very mature bull market and with the backdrop of deteriorating financial news.

This leaves C: Credit is signalling steep losses for stocks in near future (next few months). 

Move to safety accelerating

Choppy week with volatile price action. The market rallied on Friday on no news. This is not a sign of strength but nervousness. Behind to hood, the move to safer assets actually accelerated:

Speculations are rampant on ECB starting QE next week. Perhaps this will be "sell the news" event that finally rolls the big caps over.

FED behind in raising interest rates

Job openings in the private sector is a good indicator of the economic state. Lots of openings means that companies are hiring but it may also mean that there are not sufficient labor force available to fill the jobs. This leads to wage growth and inflation. Not surprisingly, FED will tend to raise rates in tandem with job openings. In this recovery cycle, FED is woefully behind the curve:

Those who expect that FED will not raise rates as they are indicating, may be surprised later this year.

Rear mirror view of the global economy

The OECD Composite Leading Indicators for November are out. Below are results for the world's four biggest economies. Notably, only US is growing although near stall speed.

Figure 1: OECD LEI for November 2014.

The OECD LEI is already two months old  at the time of publishing. In a sense, it gives as a rear view of what may happen. This has happened in the last two months: Ruble collapsed, oil collapsed, and other materials are in free fall. This is seen in the Global Growth Barometer below. 

Figure 2: Global Growth Barometer and SP500.

Materials and yield spread are signaling weakness. Quoting John Hussman: 

"the plunge in oil prices and safe-haven Treasury yields, coupled with the rise in yields on default-sensitive assets such as junk debt is most consistent with an abrupt slowing in global economic activity"

Note that Global Growth Barometer and SP500 have decoupled in 2014 and this decoupling has accelerated. Investors are ignoring clear signs of economic weakness, for now at least.

Divergences abound

Divergences can remain divergent for long time. But longer they remain, the more they matter in the end. Current divergences are breaking some records in the market. Below are some examples:

Figure 1: Credit spread divergent from stocks.

Figure 2: Stock market breath is divergent.

Figure 3: US Leading indicator is divergent.

Figure 4: Materials are signaling global slowdown.

It is hard to find more glaring divergence in the market history. When the market turns down, the move will be violent.

SP500 price to trailing twelve month earnings

Trailing twelve months is too short time frame to measure long term earnings potential. Nevertheless, past twelve months earnings (Ettm) is often used as a short hand for real fundamental analysis. Figure below shows the SP500 vs Ettm. Currently, the P/E=27 which is high by historical standards but not a record. Again, just one year P/E is not very predictive of the near future but it shows that stock market is not cheap.

Figure: SP500 vs. trailing twelve month earnings.

Households are all into stocks

Households are usually not the best market timers; they tend to get nervous and sell near market bottom and buy near the high. Keeping this in mind, the following chart is sobering:

In 2008-2009, the households pulled out record amount of money from stocks and bought bonds and treasuries. In retrospect, this was a good time to buy stocks. 

Since 2013, household have moved money from bonds and treasuries into stocks at record pace. I predict that this would be a good time to do the opposite and pull out from stocks.

Chart update for end of 2014

2014 is over. The year market another up year for SP500 and another year without -10% correction. Records are being broken. Yet, the theme for 2014 for increasing market divergence across the sectors:

Fro longer term view, the similar divergences are shown for 2011 just before the market drop but the divergence have lasted now for 12 months. Market is stretched - and this is an understatement.

Could the market stretch further. It is possible but unless the divergences are repaired, any rally from here is on borrowed time.