Last Thursday, the European Central Bank announced that it will cut its deposit rate to -0.1%. That means it now charges banks for holding excess cash, a painfully ironic move, given the concerns over the quality of European bank balance sheets.
By Friday, yields on Italian and Spanish debt touched all-time lows. By Monday, Spain joined several other European countries, including Ireland, France and Germany, whose debt has lower yields than that of 10-year Treasuries. The markets appear to be following Salvador Dali's advice, "What is important is to spread confusion, not eliminate it."
On that note, the riddle of this relentlessly rising market has left many people bewildered, and trading volumes, or the lack thereof, attest to the consternation. Volatility has also plummeted, thanks in no small part to central bankers around the world who are hell-bent on driving asset prices up while, purely by coincidence (without a trace of sarcasm from your authors), making sovereign debt easier to bear.
The S&P 500 has not dropped below it 200-day moving average since early November 2012, and it has left volatility in the dust, as we discussed two weeks ago. The 10-day advance/decline line has been at extremely elevated levels (over 2,500) since May 30, excluding the first two trading days of June. The last time the markets experienced such a run was in 1995-1996, when it spent just over a year above its 200-day moving average.
Rarely does the S&P 500 continue its upward March in perpetuity; instead there are pauses and pullbacks that let the froth out of the market. Examples of such moves include last September after the strong move in the S&P 500 in late August, late January of this year following a profound move over the October-mid-January time frame, and more recently in early April.
The difference now is that we have not seen the S&P 500 so far above both its 50-day and 200-day moving averages since mid-May 2013, following which the index fell almost 5%. We believe some protection is warranted, such as the ProShares UltraShort S&P 500 (SDS) shares, and for more aggressive investors the SDS July $26 calls. It may take a few days or a few weeks for the pullback to play out -- hence the July strike date.
The lack of volatility, lack of conviction and fear of a repeat of the 2008 crisis have also decimated trading volumes, and that means opportunity for you with brokerage firms. Markets that don't move much or that move in a relatively consistent manner don't incite a lot of trading, the bread and butter of brokerage firms. The chart below shows that equity trading volume on the NYSE has dropped nearly 40% on average since the beginning of 2010.
JPMorgan (JPM) recently warned that its trading volume will likely be down by as much as 20%, while Citigroup's (C) CFO announced that he expects second-quarter trading revenue to fall by as much as 25% from a year earlier. Recently the performance of the iShares US Broker-Dealer ETF (IAI) has diverged dramatically from the S&P's upward march, illustrating this concern.
One way to take advantage of this trend, while also getting some downside protection in a remarkably hot market, is to purchase some put options on the company that operates 17 exchanges around the world, including the New York Stock Exchange: the Intercontinental Exchange Group (ICE). We recommend the July or August puts.
Coming up in the back half of the week, we'll get two key pieces of data for May: retail sales and the producer price index (PPI). Earlier this week, Federal Reserve Bank of St. Louis President James Bullard echoed some of our concerns when he commented this week that inflation is now "moving higher."
That is a shift in his position from just last month, when he professed that inflation was stable; however, as we pointed out last week, we have seen a number of reports show an upward move in prices. We can add to the list dairy prices. According to the Bureau of Labor Statistics, a gallon of fortified whole milk cost $3.69 in April 2014, a 7.5% increase from a year earlier and the highest price since September 2011. Not bad for dairy farmers and companies such as Deere (DE) and AGCO (AGCO) that cater to them, but not good news for companies such as Domino's (DPZ) or Papa John's (PZZA) that use hefty amounts of cheese, not to mention the pocketbooks of low-income earners. As you can imagine, we will be watching the May PPI reading rather closely.
With regard to retail sales, excluding auto sales April was essentially flat and not quite what many had expected, given the timing of the Easter holiday. We put ourselves in that camp. We already know that May auto sales were robust, and when coupled with the price creep we are already seeing, it raises the questions for us and some concern that consumers are likely to pull back their spending. If we are correct in that, it means consumers will be buying what they need rather than what they want.
That would be favorable news for companies such as Procter & Gamble (PG), Colgate-Palmolive (CL), Unilever (UN) and, if Brian Sozzi is right about increasing condom and vibrator usage, Church & Dwight (CHD) will have the markets buzzing and is a reminder of the need for protection these days.