Data suggests more upside

Coming off a weekend of political disappointment, it’s easy to get caught up in the emotions of it all. As I pointed out, the market was due for a pullback, and it got a reason to. We can “beat a dead horse” and dissect all of the “what-if” scenarios and implications of the failure. But none of this will be fruitful for your investment decisions. We know that pullbacks and corrections are an inevitable part of investing. And once in awhile we get a major decline, usually due to a recession. The key question is does the data suggest a business cycle peak?

The short answer is no.

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Consumer confidence numbers just came out at a high not seen since November 2000.

Small business optimism

Scott Grannis points out that Small Business Optimism has soared post election and is near all time highs.

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Earnings growth is finally back and is projected to be around 9-11% for 2017. This would be the largest annual increase in earnings since 2011. And this doesn’t even factor in the potential for tax reform and repatriation.

And interest rates are still very low. The earnings yield on the S&P 500 is currently 5.59%, while the 10 year treasury bond yield sits at 2.38%. Even the Fed’s overly optimistic projection suggests the real Federal Funds rate won’t even turn positive until another two years or so. So, even though valuations are on the high side and interest rates have risen quite a bit post elections, stocks still present an attractive risk premium.

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An interesting chart to follow going forward is the ten year yield. Post election the 10 year yield has risen on the assumption of pro-growth policies of the new administration. Since then a trading range between 2.3% and 2.62% has been formed. An upside breakout suggests all is clear, while a breakdown suggests that more of the President’s agenda may be in jeopardy.

Time will tell. But for now, things are looking pretty good to me. But I parse this by saying we’re probably closer to the end of the bull market, than we are to the beginning. The stock market and the economy don’t always correlate. We’ve had great performance in stocks over the last 8 years, while the economy largely under-performed. I wouldn’t be surprised if, going forward, we experience a situation where the economy starts to outperform, while stock performance slows down to an eventual crawl.

The great thing about diversification and asset allocation is that we don’t have to be prophetic. We stick to our strategy and re-balance when necessary. It’s that simple, but certainly not easy.

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Pullback finds short term support…

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In last week’s update post we talked about the confluence of short term support near the 1900 level on the S+P 500 and a projected downside target of 1908 was given. That proved to be correct as the S+P 500 put in a low this week of 1904.78 and then proceeded to finish the week with a rally over one percent on Friday.

The daily chart above shows how the S+P 500 has now matched the 83 point pullback experienced in April. And I believe now that the risk-reward (at least in the short term) favors the long side for the time being.

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Along with the confluence of support in the S+P 500, the Dow Jones Industrial Average ran into it’s own support, that being in the form of it’s 200 day moving average (as depicted in the chart above). I believe the confluence of these key technical levels makes the probabilities favor at least a larger retracement rally.

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Just how much we should expect? Well I think a first logical target between 1950 and 1960 is most probable. I have included the above chart to explain a little about why I feel this is so. The chart above happens to be a 15 minute chart that highlights this specific pullback. So far we have seen two separate but equal 17 point retraces and two separate but equal 27 point retraces (where we find ourselves now).

Because of the confluence of support that we have mentioned, I believe this retracement will exceed that of the previous ones. A retracement double the size of the previous (or 54 points) is certainly possible. In this case we add 54 points to the swing low this week and we get 1958 as an upside target. This happens to coincide with the 61.8% retracement level of this most current pullback, along with the 50 day moving average.

I must stress that this is only an educated guess, the Intermediate and Long term trends remain bullish so we must give it the benefit of the doubt. The short term trend remains bearish below 1960. Only time will tell if this pullback turns into something more.

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Another thing worth watching will be the S+P 500 advance – decline line. We would like to see any retracement rally in the major averages be accompanied by a rally that takes this market internal reading back above it’s 50 day moving average as well.

Some quick market observations…

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Over the last six months especially, we’ve seen tremendous strength in the cumulative advance decline line. Seeing these continued higher highs on the price chart above, it really shouldn’t come as much of a surprise that most of the broader market has been “grinding” higher as well.

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One of the least talked about, but arguably the most important index is that of the S+P 100. Wikipedia explains it’s significance the best:

“The S&P 100, a subset of the S&P 500, includes 100 leading U.S. stocks with exchange-listed options. Constituents of the S&P 100 are selected for sector balance and represent about 57% of the market capitalization of the S&P 500 and almost 45% of the market capitalization of the U.S. equity markets. The stocks in the S&P 100 tend to be the largest and most established companies in the S&P 500.”

“The average market capitalization (weighted by market capitalization) of the S&P 100 is about twice that of the S&P 500 ($142 bn vs $68 bn as of April 2014). So it is larger than a large-cap index.”

In the long term chart above we now see this index has finally taken out it’s 2007 high. As the traditional S+P 500 index made a new all time high back in early 2013.

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Another observation comes from the Dow Jones Industrial Average and it’s long term trend line above, as denoted in the above chart.

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Taking a closer look at this trend line shows how it has seemed to do a decent job, as the index appears to be having some difficulty in getting and staying above. This could all change in an instant, there are some mixed messages the market has been sending this year. We have pointed out many of them. The likely explanation is a reversion to the mean, or consolidation, after such a tremendous year 2013 was for risk assets. I think it’s prudent to give the dominant trend the benefit of the doubt until it proves otherwise. History tells us there will be a double digit correction at some point. Unfortunately there is just no way for one to know in advance.

For now, these are just a few these that I am watching.

Market Summary: Outside reversal day as Dow gets rejected at Long term resistance once again…

We pointed out this interesting long term pattern in the Dow last year. This week, for the second time, we tested those resistance levels. On Friday, after hitting resistance the Dow (and all other major averages) put in an outside reversal day lower, closing at lows.

This daily chart of the Dow notates this second rejection. I continue to maintain this cautious approach as risk vs reward may or may not be ideal at these price levels. And as we took a look at, continued weakness abroad many of the growth and momentum names. However as we will see in this post, when we take a look at the big picture we still see a bull trend in tact. So although cautious, I don’t see any reason for panic.

Looking at the S+P 500 daily chart above, we see the tough day that Friday was. However even with Friday’s action, the S+P still put in a positive close on the week and trades positive year to date, still above it’s 50 and 200 day moving average.

One index that I don’t hear much talk about is the S+P 100. This index holds 100 of the largest stocks by market cap. It’s very close to it’s 2007 highs now, a potential added confluence for resistance, at least on first touch.

The Nasdaq is under more selling pressure as it’s 5.58% below it’s highs and negative year to date.

We can see the difference as the percentage of stocks on the New York Stock Exchange trading above their 150 day moving average is 72% (a healthy number).

Whereas the percentage of stocks on the Nasdaq trading above their 150 day moving averages is 55%, still a good number, anything above 50% is pretty healthy.

It was interesting to note that with Friday’s ugly day the Volatility index was only up about 4%. It’s really hard to get overly bearish with a VIX reading sub 20.

The cumulative advance – decline lines for both the S+P 500 and the New York Stock Exchange continue in solid up trends.

The spread between high yield and treasury bonds have even firmed up a bit,  holding it’s 200 day moving average.

Sector performance year to date continues to favor Utilities and Health Care.

Performance by asset class year to date.
Lastly the trend matrix continues it’s moderately bullish theme, there were no changes from last week. This is not a market timing tool, but rather a gauge of the direction of the overall trend and the strength thereof. The stocks in the S+P 500 trading 20% or greater below it’s 52 week high has ticked down to 6.8%, down from 7.0% last week.
So there you have it, we do have some resistance levels above to keep an eye on. However the underlying trend and internals continues to be supportive. 

Market Summary: This is not 2013…

So far in 2014, market returns on the equity side of the allocation have been hard to come by. After 61 trading days for the year 2014, only the S+P 500 is showing a slight gain (below 1%). The Dow, Nasdaq and Russell 2000 (small caps) are all in negative territory year to date, although not by much.

Let’s rewind to year 2013 and we see that the first 61 days last year proved to be much better for equities. At this point last year, three out of the four major averages were sporting double digit returns already. 
In January of this year the S+P 500 matched it’s biggest correction of 2013 before rebounding and making another all time high. The market is currently stuck between a range defined by 1840-1880 swing high/low pivots. However even with all the recent volatility the S+P 500 remains only 1.5% off it’s all time highs.
This 60 minute chart above shows this recent trading a little more closely. A break below 1840 sets up the expectations for a drop to at least 1809-1799, the zone that is marked on this chart above. Of course a break above would likely setup the expectations for a rally to new highs to 1940 or so. 
The Dow Jones average has been in negative territory all year after hitting long term resistance projected in the pattern we defined going back to last year. The Dow started off the year by matching and slightly exceeding it’s biggest correction size of 2013 before rebounding. Unlike the S+P 500 it failed to make new highs on the rally and now sits inside a similar trading range to the S+P 500. 
The Nasdaq also matched its biggest correction of 2013 during the January drop. However more recently we have seen more weakness in the small caps and the tech heavy NASDAQ. While the S+P and Dow continue it’s trading ranges the Nasdaq and Russell have actually broken down a bit. The Nasdaq is 5.5% off it’s highs as of Friday’s close.
The Russell 2000 is also 5% off it’s highs and has made a recent lower low as it dips below it’s 50 day moving average. The Nasdaq and Russell still remain in bullish up trends however this weakness is worth noting as it signals a possible reduction is risk taking. 

The market internals still look strong as both the New York Stock Exchange and the S+P 500 advance – decline lines remain in solid positive territory year to date.

New 52 week highs on the New York Stock Exchange are in short term oversold territory as the bearish divergence continues.

Another bearish divergence can be found when looking at the spread between high yield bonds to treasury bonds. A higher reading means investors are more willing to buy higher yielding (riskier) bonds in place of (safer) treasury bonds.

Sector performance year to date shows Utilities taking the clear number one spot, showing returns of 9%. Health care has been under pressure of late due to the recent volatility in Biotech, which now makes up almost 20% of the sector. Cyclicals, 2013’s best performing sector, comes in as the biggest under performer as of Friday’s close.

Asset performance year to date continues to show relative strength in Treasury’s and Gold, while emerging markets is starting to show some life but still comes in as the laggard year to date so far.
The trend matrix continues in it’s bullish theme, although slightly less bullish than it was two weeks ago. As the Nasdaq 100 (QQQ) small caps (IWM) and Consumer Discretionary (XLY) sector turn from a Bullish to Neutral trend reading. This is not a market timing tool but rather a gauge of the direction of the dominant trend and the strength thereof.
Another indicator I follow is how many stocks in the S+P 500 are in bear market territory. I use stocks trading below 20% from it’s 52 week high as my criteria. Last week the reading came in as 6% of S+P 500 stocks in bear market territory. As of Friday’s close that number has now gone up to 7%. Still far from danger territory but worth watching nonetheless.

In conclusion, I am still concerned with the potential downside risks in equities over the short term. However with all four of the major averages in up trends above their 50 and 200 day moving averages and the market internal readings as strong as ever, there is absolutely no reason to jump the gun and start crying market top. Investors expecting 2013 type returns from equities may very well be dissapointed, but that doesn’t mean we can’t get a 10-15% return in equities by year’s end. All it proves is the importance of diversification among asset classes. Those investors that chose to re-balance their portfolios by rotating some of their stock earnings into their bond allocation have been rewarded.