Equities Through the European Close at 11:30 A.M., but Stocks Recovered Through the Mid-Afternoon

June 29, 2016

The front month VIX futures spread closed positive Friday for the first time since February. And though it pulled back Pre 7:00 Look yesterday, the trend continues to suggest volatility will remain elevated in the near term.  US futures are trading higher this morning as international shares extended gains o/n thanks to continued stability in the an actual news standpoint things probably got anecdo- British pound and rallying oil prices. tally worse between Great Britain and the EU (more on  Oil futures are up over 1% after the API reported a –3.9M that tomorrow). barrel draw in oil stocks for last week vs. (E) -2.0M barrels. If there was one catalyst for the rally yesterday it was  Although the global stock gains suggest a rising appetite for the bounce in the pound, which was obviously driven by risk, global bond markets remain firm, pointing to continued “Brexit angst.” short covering. News wise, there were headlines from Europe regarding a special session of the European Par-  Econ Today: Personal Incomes and Outlays (E: 0.3%, 0.4%), Pending Home Sales Index (E: -1.0%). Fed Speak: Yellen (9:30 liament and the EU Leaders Summit, but none of those a.m. ET) moved markets or changed the Brexit outlook. From a data standpoint, the final read on Q1 GDP slightly Market Level Change % Change beat estimates but remained low on an absolute level, S&P 500 Futures 2041.75 13.25 0.65% and especially given the Brexit news that report is simply U.S. Dollar (DXY) 96.005 -.326 -0.34% very, very dated. Gold 1320.10 2.20 0.17% WTI 48.43 .58 1.21% In true short-covering fashion, stocks spiked on the open 10 Year 1.461 .001 0.07% Tuesday and the high for the majority of the day was set by 10 a.m. Markets gave back some of those initial gains Equities through the European close at 11:30 a.m., but stocks recovered through the mid-afternoon. Market Recap Then, at 2:30 p.m. following the close in oil, stocks shot Stocks enjoyed a standard oversold bounce Tuesday as higher as the pound and oil surged while the dollar sellers became exhausted in the short term and that caused some short covering, which was all stocks need- Market Level Change % Change ed to rally (there was no new, positive event that hap- Dow 17,409.72 269.48 1.57% pened yesterday). The S&P 500 surged 1.78%. TSX 13,842.69 152.90 1.12% Stoxx 50 2,819.73 61.06 2.21% Stocks were higher early Tuesday as markets simply got FTSE 6,271.85 131.46 2.14% too short-term oversold. There really wasn’t any catalyst Nikkei 15,566.83 243.69 1.59% for the bounce yesterday other than some profit taking Hang Seng 20,436.12 263.66 1.31% ASX that simply fed on itself as the day went on. In fact, from 5,142.40 39.12 0.77% Prices taken at previous day market close. Copyright 2016, Kinsale Trading LLC. All Rights Reserved. www.sevensreport.com dropped. There was no specific catalyst for the move Unfortunately, the facts tell us neither event is likely. If and it was mostly positioning ahead of the final hour. the idea that there won’t be a Brexit gains more trac- Market Level Change % Change tion, we will explain the facts be- The Turkish airport bombing hind our skepticism, but today we headlines hit during the final DBC 15.21 .23 1.54% Gold thought we’d give you a break hour, and caused a mild dip at 1315.90 -8.80 -0.66% Silver 17.870 .084 0.47% from European and British political 3:00 p.m., but that didn’t last Copper 2.1795 0.54 2.54% analysis (there will be plenty of it long and the S&P 500 closed basi- WTI 47.81 1.48 3.19% in our collective futures). cally on the highs, and impres- Brent 49.21 1.44 3.01% sively recouped all of Monday’s Nat Gas 2.881 .14 5.11% Bottom line, the idea there might RBOB losses. 1.5100 .0333 2.26% not be an actual Brexit seems to DBA (Grains) 21.99 .21 0.96% be born out of hope rather than Trading Color Prices taken at previous day market close. the reality of last week’s vote (the I’m not going to spend much time here because the in- media, financial community and intelligentsia in Europe ternals confirmed what we all know, and that is that yes- still don’t seem to be able to grasp that every major re- terday’s rally was an oversold bounce. First, the most gion in the England, except London, voted to Leave). beat-up sectors (Europe, banks, financials and energy) all From a future catalyst standpoint, and looking beyond outperformed and rallied 2%-to-3% on short covering. the bounce (which could last a few days), a few things Second, all the recent outperformers (utilities, consumer need to happen before we even entertain the idea this staples, gold stocks) underperformed as XLU, XLP and Brexit pullback is over. FXG rose, but lagged the S&P 500 while gold stocks dropped modestly. First, the dollar needs to drop. The rising dollar remains the No. 1 biggest fundamental threat to the US stock Broadly, all nine SPDRs we watch closed higher yester- market, as a stubbornly high dollar will weigh on corpo- day, and overall it was your classic oversold bounce on rate earnings and make an already fully valued market relatively low volume. On the charts, the S&P 500 closed more expensive. just below resistance in the 2,040-2,050 range, and that’s a level to watch today. Second, the SX7P (the STOXX European Bank Index), which bounced 2% yesterday, needs to hold Monday’s Bottom Line low of 117.53. Was that it? Have cooler heads prevailed now that the Third, central banks needs to control themselves. Over market has had time to digest Brexit? the past few years every major market event has been No, probably not. I’m very skeptical that yesterday’s mild met with rhetorical easing or actual easing. But that dy- rally marked a near-term bottom in this market, mainly namic has changed, and many analysts and investors because the reasons behind the bounce weren’t particu- (me included) are not entirely convinced that central larly positive. banks doing more won’t actually cause more problems. First, it was mostly a textbook oversold bounce as the The last thing we need right now is more pressure on S&P 500 dropped nearly 6% in two days, and that banks (especially UK banks) and substantial rate cuts (usually) isn’t sustainable. near or into negative territory might do more harm than Second, the obligatory assigned reason for the rally good, regardless of whether it’s the BOJ, BOE, ECB, etc. (other than just an oversold bounce) was a growing Bottom line, stay defensive with equity allocations, as sense of hope that maybe Brexit won’t actually occur. we do not think now is the time to try and jump in and The idea is that there may be another referendum, or buy the dip, except with a small portion of risk capital if Britain may use the vote to negotiate an “associate” sta- you’re so inclined. tus within the EU.

VIX Spread Update: Confirming The Downtrend in Stocks Bottom line, the final look at Q1 GDP implied an economy that wasn’t as bad as feared, but still wasn’t very Two weeks ago, we first mentioned that the price action good either. Most importantly, nothing in the report in VIX futures (specifically in the front month calendar raised expectations for Q2 growth to move materially spread) was beginning to turn bullish, a development above the current 2% expectation, and that was before that has proceeded stock market pullbacks in August last the Brexit vote. year, and January of this year. On Friday, the front month VIX futures spread closed Commodities positive (shifting from contango to backwardation) for Commodities were mostly higher yesterday as money the first time since - mid February, when the S&P 500 flows sharply reversed from risk-off to risk-on overnight bottomed just above 1,800. The reason we point this out Monday, and the dollar pulled back from its post-Brexit is in recent history, when the front month VIX spread surge. Gold was a notable underperformer on the day as has been trending higher or positive, as it is so far this demand for safer assets declined. The commodity ETF, week, it has coincided with stock market weakness. So, DBC, rose 1.60%. until the “trend,” which we define by using moving aver- Beginning with the energy market, WTI crude oil futures ages, turns lower and the spread falls back into contango rose 3.35%, half due to the renewed appetite for risk for multiple closes, the risk in stocks is skewed to the and half based on fundamental supply and demand. downside. The risk-on bid across asset classes is self-explanatory, Economics so turning to the fundamentals, news of potential strikes Final Revision to Q1 2016 GDP in Norway that would take effect Saturday brought a fear bid into the market—even though the affected  Final Q1 GDP rose 1.1% vs. (E) 1.0%. fields only account for 285K b/d of production, which is Takeaway less than 0.3% of daily global production. Although the The upward revisions to Q1 GDP continued with the final potential strike made great headlines, it is not a materi- reading, but while there were some anecdotal positives, ally bullish development for the oil market near term. it was more a report of “gives and takes,” and in general Looking back closer to home, the WSJ’s estimates for growth in Q1 remained soft, and nothing in the report this morning’s EIA report were released yesterday with points to a meaningful acceleration in Q2 (and that was the consensus estimate calling for a 2M barrel draw in before Brexit uncertainty). oil supply to be reported in the weekly report. Remem- Positively, Final Sales of Domestic Product (which is GDP ber, the headlines are still important for intraday price less inventories, and a better gauge of actual growth) action, but the production figures in the details ofthe was revised to 1.3% from 1.0%, a report remain a key underlying Market Level Change % Change driver of the energy market right clearly positive step—although Dollar Index 96.225 -.478 -0.49% on an absolute basis still soft. EUR/USD 1.1059 .0034 0.31% now, as the US remains the GBP/USD 1.3339 .0114 0.86% world’s swing producer given Conversely, Personal Consump- USD/JPY 102.73 .73 0.72% OPEC’s full-throttle policy. tion Expenditures (consumer USD/CAD 1.3056 -.0016 -0.12% spending) was revised lower from AUD/USD .7367 .0037 0.50% Bottom line, the combination of 1.9% to 1.5%) while the Core PCE USD/BRL 3.3035 -.0893 -2.63% fundamental fear bids and risk- Price Index was revised slightly 10 Year Yield 1.461 .001 0.07% on money flows were the main 30 Year Yield 2.275 -.004 -0.18% lower to 2.0% yoy from 2.1%, and reasons for the pop in oil yester- Prices taken at previous day market close. that’s not a number that would day, but neither of those two have made the Fed hawkish even before Brexit. things are supportive of a sustainable, long-term rally in oil. And, the term structure (calendar spreads) of the oil

Copyright 2016, Kinsale Trading LLC. All Rights Reserved. www.sevensreport.com market remains notably weak, and leave us with a bear- this market than the stock market would suggest. Look- ish outlook on oil in the medium term. ing ahead, a continued rebound in the pound and subse- quently in stocks would influence a further move higher Gold fell 0.75% yesterday thanks to diminishing demand in the dollar/yen, but the longer-term trend is still lower, for safe-haven assets amid the global bounce in equities. and will remain so unless Japanese authorities intervene Volatility remains elevated across assets, but specifically with substantial easing measures. in gold since the Brexit results last week, and that is set to continue as the implications for global markets are Shifting gears and looking to the bond market, Treasur- digested. On the charts, important support lies between ies remained resilient yesterday, ending the day little $1,300 and $1,305 while there is initial resistance up changed despite the broad risk-on price action across towards $1,320. other markets that left many expecting a pullback. The Currencies & Bonds 10-year yield edged up marginally to 1.461% while the yield on the long bond actually fell slightly to 2.275%. The theme in the markets was risk-on yesterday, and the The fact that bonds didn’t pullback yesterday amid a currency markets were one of the main reasons for that more-than-2% rally in US stocks points to how on edge as the pound bounced modestly after two days of steep investors remain following the Brexit vote. loses in the wake of the Brexit vote. The euro also rallied while the dollar and the yen pulled back. The Dollar In- To us, the overwhelmingly strong bid that remains in the dex finished the day down 0.49%. Treasury market is a warning sign that we will continue to be focused on, because while stocks can continue to The dollar is currently trading like a safe-haven currency, rebound with the pound in the near term, we are still in rallying when volatility rises and selling off when risk ap- a “something has to give” situation between stocks and petites return to the market. The reason is obviously the bonds. And based on the momentum behind this Treas- greenback’s inverse correlation to the euro and the ury rally, the more likely outcome has stocks giving in pound (which are trading together right now based on and correcting lower rather than seeing bonds roll over. regional uncertainties). That relationship is poised to continue as the Brexit drama remains top of news and Have a good day, the primary influence on global markets. On the charts Tom the dollar made a near-term, bullish break higher, but on a medium time frame remains very much range bound in the 90s. Taking a technical look at the pound, yesterday’s 0.93% rally so far hasn't proven to be anything more than a dead-cat bounce, as yesterday’s “daily bar” was contained within the previous days bar. That suggests price action is indecisive and consolidative in nature. That leaves the path of least resistance lower as the bulls have most-recently controlled the market, and as such we maintain our downside target of 1.29 based on a measured move, and will begin to look for signs of the pound bottoming around that level in the near future.

The yen pulled back yesterday as the USD/JPY added 0.64% on the day, but the pair continues to trade with a 102 handle, which is still well below resistance at 104, and suggests there is more demand for safe-havens in

Technical Perspectives (Updated 6/26/16)

S&P 500

 Fundamental Outlook: Remains cautious based on valuations and a generally unfa- vorable risk-reward scenario.  Dow Theory: Remains bearish (since week of August 17, 2015)  Key Resistance Levels: 2050, 2071, 2093  Key Support Levels: 2016, 1981, 1932

WTI Crude Oil

 Fundamental Outlook: Neutral as the global production surplus is seen balancing sooner than originally thought, but the pace of US production declines is slowing.  Proprietary Model: Bearish (since week of June 13, 2016)  Key Resistance Levels: $49.00, $50,20, $51.50  Key Support Levels: $46.55, $45.99, $44.53

Gold

 Fundamental Outlook: Favoring the bulls as investor sentiment is deteriorating amid fears that the global economy is weakening, especially after the Brexit vote.  Proprietary Model: Bullish (since week of June 6, 2016)  Key Resistance Levels: $1326.10, $1338.80, $1350.20  Key Support Levels: $1301.60, $1285.70, $1265.00

30-Year T-Bond Futures

 Fundamental Outlook: Favoring the bulls as investor sentiment is deteriorating amid fears that the global economy is weakening, especially after the Brexit vote.  Proprietary Model: Bullish (since week of May 30, 2016)  Key Resistance Levels: 171’06, 172’07, 173’17  Key Support Levels: 170’00, 168’15, 166’31

Dollar Index Futures

 Fundamental Outlook: Neutral to bearish as Fed policy outlook is extremely cloudy while global economic data is not currently conducive to a rate hike in the near term.  Proprietary Model: Bullish (since week of June 27, 2016)  Key Resistance Levels: 95.86, 96.075, 96.65  Key Support Levels: 95.03, 94.15, 93.62

Fundamental Market View (Updated 6/26/16)

Near-Term General US Stock Market Outlook This is designed to provide a snapshot of our near-term (1 month) outlook for stocks. For general equity market exposure, we use a mix of SPHB (S&P 500 High Beta) and SPLV (S&P 500 Low Volatility) to create an aggressive, neutral or defensive stance on general equity market exposure.

Near Term Stock Market Last week was historically volatile for stocks as markets spiked assuming a Outlook: “remain” Brexit vote, then plunged Friday following the shock “leave” victory. Go- ing forward, Brexit creates a lot of additional uncertainty and will provide upward Defensive support for the dollar, and we believe both those headwinds make a sustainable SPHB: 25% SPLV: 75% rally in stocks a lot less likely. We remain cautious on stocks broadly.

Tactical Allocation Ideas:  What’s Outperforming: Defensive Sectors (XLU/XLP, FXG), Short Duration TIPS ETF (VTIP), Inverse Emerging Market ETF (EUM), Super Cap Internet/Social Media Stocks (AMZN, FB, GOOGL, LNKD, FDN is a good internet ETF).  What’s Underperforming: Europe (HEDJ/VGK), Banks, (KRE), Retail (XRT), Tech (AAPL related supply chain), Healthcare (especially specialty pharma and biotech stocks), Small Caps.

Fundamental Outlook for Other Asset Classes

Fundamental Market Intelligence Outlook

Commodities dropped nearly 2% thanks almost entirely to the risk-off move following the Brexit vote Friday. But even looking beyond that macro event, outside of gold fundamentals, most industrial Commodities Neutral commodities have been quietly getting more bearish, and that remained the case this week. Going forward, the Brexit result is dollar positive, and between that and potentially shifting oil fundamentals the commodity complex ex-gold will face stiff headwinds.

The Dollar Index surged nearly 2% largely on Friday thanks to the surprise Brexit result. Going forward, while the Fed may no longer hike rates in 2016, the pound and euro will be under consistent US Dollar Neutral pressure and a new uptrend in the dollar has likely begun solely because of other currency weakness, although the rally in the dollar should be more gradual going forward.

Treasuries exploded higher, and at this point it’s likely only a matter of time until the multi-year lows in yields in both the 10 and 30 year (lows from mid-2012) are broken. With the Brexit result casting a Treasuries Bearish shadow of political uncertainty on Europe, demand for Treasuries will only get stronger due to demand from foreign buyers, and thanks to a more dovish Fed.

This page is meant to provide a general outlook for the path of each major asset class and is updated at the start of each week.

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