You don’t have to look any further than the price movements of one of the most industrial commodities, metallurgical coal, to see what is really happening with the global economy.  ‘Met coal’ is used primarily in steel making and the largest end market has been China, so it is a very good indicator of real global demand for industrial metals.  A dramatic example of China’s use of coal was the fact that it had grown from 4% of world use in 1970 to 8% in 1988 and to 50% in 2013, the world’s most remarkable expansion in the use of anything since time began!  Yet this remarkable surge was followed in 2014 by a reduction in China’s use of coal; a year in which China was still growing at over 6%.  As shown in the chart below, Met coal prices peaked at over US$325 per tonne in 2012 when supplies were restricted during the Australian floods.  Prices have collapsed since that point, falling to recent lows of just over US$100 per tonne, with transactions taking place at 10-15% discounts to those official prices.

Reduction in China's use of Coal Given these conditions, it’s no surprise that Canada’s largest coal producer, Teck Resources, has fallen over 80% during the last four years.  It doesn’t help that their other key product is copper and that all of their excess cash flow is now going into the Fort Hills oil sands development.  While the resource sector has been under tremendous pressure over the past few months and is significantly below the peaks seen in 2011, sellers continue to come out and markets do tend to overshoot on the downside as well as the upside.  While longer-term valuations are starting to look interesting, it is still not clear how long this downturn in prices will go on and it’s probably still too early to start accumulating stocks in the Energy and Basic Materials sector, outside of some shorter-term trading opportunities.

Even though we see more downside economic risks, we have to pay attention to the earnings and commentaries coming out from companies, particularly those that do business globally.  Those numbers have been mixed and fall into two clearly different categories.  The global industrial companies such as Caterpillar, Dupont, IBM, Microsoft and United Technologies have generally reported somewhat weaker results and also gave less positive guidance going forward as slowing economic growth (and a stronger U.S. dollar) caused headwinds to earnings.  However, the financials and growth-oriented companies have had strong results which have given further support to their high valuations.  Netflix, Google, Gilead Sciences, Valeant Pharma, Amazon, Facebook and Disney have all reported numbers above expectations and seen substantial rises in their valuations.  Google alone added over US$60 billion to its market capitalization in one day after reported strong earnings while Amazon Inc. stock increased by over $100 per share on the day showing its earnings release.

Such ‘narrow’ advances in the stock market are generally not healthy though and are more indicative of a very mature stock advance.  There has been very little ‘breadth’ to the gains in the U.S. indices in 2015.  More than 100 percent of this year’s increase in the S&P’s 500 Index is attributable to two sectors, health-care and retail.  That’s the tightest clustering for an advancing year since at least 2000, leading up to the end of the technology bubble.  Adding to those concerns is the fact that the two industries shouldering this year’s advance trade at more than 22 times earnings, a 20% premium to everything else.  Reliance on fewer and fewer companies has been a hallmark of maturing bull markets, most memorably the Internet bubble when six computer and software companies accounted for 55 percent of the S&P 500’s gain over the 12 months leading up to the peak.  The situation is even more extreme when we look deeper and find that only six firms— Amazon, Google, Apple, Disney, Facebook and Gilead Sciences— account for more than all of the $200 billion in market-capitalization gains in the S&P 500.  The question for most is does this equal prior market tops—including the 2007 peak and the late 1990s frenzy—when fewer and fewer stocks lifted the broader market?  On the eve of the dot-com crash in March 2000, the top six stocks in the S&P had accounted for all of the index’s market-cap gain that year.

Even though U.S. growth stocks continue to act well, the same cannot be said about other global stock markets or even other sectors of the U.S. market.  While we have seen substantial corrections in Canadian, European, Chinese and many Emerging Economies stock markets this year, the U.S. averages have stayed close to all-time highs.  But looking further below the surface shows a more distressing outlook in many key sectors.  While there was much focus on the inability of the Dow Transport Average to move to new highs along with Dow Industrials Average (thereby failing to support the 100 year-old ‘Dow Theory’), we are also now seeing a breakdown in the key Industrial sector of the S&P500 as shown in the chart below.  For the ‘non-technician’ readers, the ‘death cross’ shown in the top right of the chart refers to a point where the 50-day moving average breaks down below the 200-day moving average.  Although no technical indicator is infallible, this one has a pretty good track record of pointing to weaker prices ahead.  Adding to the negative technical outlook is the breakdown of the index below the ‘trendline from August 2011’ (which was the last time the U.S. market experienced a correction of more than 10%).

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