Bulls Just Can’t Get Going

Something is clearly wrong with the bulls this month. With two reversal days out of three ending this past Monday, stocks should have been a lot higher than they are right now. Every single rally is being met with selling and that is a giant change in character. I have pounded and pounded the table that the bull market remains intact. And while there is still enough evidence to suggest that, I have to be open to the idea that I may be wrong.

Besides the fact that the bulls cannot muster any sustainable upside whatsoever, banks and transports look like death. While that’s not the end of the world, the long-term trend of the stock market, the average price of the last 200 days, has completely flattened out and is now close to turning down. Also, not only are stocks declining on bad news, but they are also doing so on good news.

Given the negative action this morning and that today is Friday, I think the stock market will likely be on the defensive into next week which is another very unusual sign for the bulls. Again, we typically do not see weakness this late in the year, especially of this magnitude.

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Looking Under the Hood of a Midday Waterfall Decline

This is going to be a little different kind of article that focuses on the minute to minute moves in the stock market. People often ask what happened or why something happened in the middle of the day which seemed rather large and out of the blue. Last week’s 800 point down Tuesday had two very obvious things occur so I am going to share.  Below is a chart that I found very interesting. Each little red or green bar represents 5 minutes in the trading day for Monday and Tuesday.   Monday’s sharply higher open was due to a few relatively benign words from Presidents Trump and Xi regarding their tariff tantrum. Frankly, I was a little surprised at just how high stocks were set to open as I wrote about on www.investfortomorrowblog.com as well as on Twitter. I thought for the most nimble of traders, smart money would be selling into that news. In hindsight I certainly wished I was that smart money doing the selling after what has transpired since Monday’s open.   As stocks traded towards the unchanged level on Monday, the S&P 500, which is the one index computerized traders use most, breached the average price of the last 200 days, also known as the 200 day moving average. I have long written about this widely followed gauge of the long-term trend for stocks. While we do not use it in our work, so many other people do that it warrants paying attention to its level. 

Above, you can see the arrow where where the S&P 500 breached the 200 day moving average. What happened next was fascinating if you are in to that sort of thing. You can see that the S&P 500 began to accelerate lower without any attempts to rally. In trading terms, that was very heavy, like trying to breathe with elephant sitting on your chest.   To gauge the intensity of that breach of the 200 day moving average, we turn to the chart below which is almost all noise. On the left side you can see Monday’s high point right at the open. Without getting too technical and boring you even more, the levels that matter on the chart are those above 1000 or below -1000. That’s where you can see intense buying (+1000) or selling (-1000). On Monday, the bulls got sucked in for a few minutes before having the rug pulled from beneath them.   Now look at the bottom of the chart for Tuesday where I show lots of little arrows. There, as the S&P 500 was breaking below the widely watched level of 2760, institutional investors using sophisticated computer programs hit the sell button to get out at any price. They didn’t care where as long as it was right away. The selling was intense and broad-based. We do not know exactly why.    

The first few programs around noon were accompanied by massive buying in the bond market, so we can reasonably conclude that at least one big player was selling stocks to buy bonds. Beyond that, there isn’t a lot to offer. 

I share this with you not because there is anything to glean from it regarding our strategies or your money, but rather just to give you a glimpse into what can happen during big market days.

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Unusual Volatility

December and Q4 continue my longstanding theme of increased volatility. It’s definitely unusual for stocks to be this volatile this late in the year and without doing my homework, 2008 and 2000 come to mind. Of course, this looks nothing like 2008, but 2000 does have vaguely similar comparisons. Stocks are certainly pricing in a much more negative outcome than we have seen in a while.

As I have said before, I definitely did not see the magnitude of the December decline. I thought it would have been much more contained. Stocks look like they bottomed on Monday, but there has been little follow through since. Additionally, all strength has been sold since then. That’s a bit unnerving for the bulls and something we have not seen in a while.

On the good side, the NASDAQ 100 is leading. High yield bonds have finally stepped up. Semis, software and internet are leading. But so are staples, utilities and REITs, the defensive group. Banks look like absolute death, almost to the point of being so bad, they’re good. Lots of crosscurrents right now. It’s either an hour to hour, day to day market or one you should not pay attention to until January.

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Higher Rates Are to Blame. Lower Rates Are to Blame

Everywhere I turn, there seems to be another reason for this correction. Slowing in Europe, China falling off a cliff, tariffs, soaring long-term interest rates, yield curve inversion, deceleration in the U.S. economy. I have heard it all. The problem is that none of these reasons can easily be tied to the decline directly, nor should they be. And every once in a while, declines occur and the reasons are not apparent until well after the fact.

Let’s look at interest rates which has probably been blamed more than anything else. You can see below on the 10 year treasury note from 2018 that yields had been moving much higher all year. And they actually went straight up in September as stocks were also rising sharply. During the sharpest leg of the stock market correction  in October, rates were somewhat all over the place. Yet, since the beginning of November, rates have come way down, along with stocks. It’s really hard to conclude that higher interest rates are responsible for this decline.  

More recently, pundits and the media have been pounding the table about the yield curve boogeyman. The yield curve on the short end has inverted. Perhaps you are wondering, “what the heck is the yield curve and why on earth should I care?”
The yield curve is very simply the difference between two interest rates or yields. For example, if the 10 year note is yielding 3% and 2 year note is yielding 2%, the yield curve is positive by 1%. It’s always the longer maturity minus the shorter one. Investors look at all different yield curve components ranging from the three month treasury bill to the two, three, five and ten year treasury notes and out to the 30 year treasury bond.

Almost all of the time, the various yield curves are “ordered” properly, meaning that the 30 year bond has the highest yield, followed by the 10 year, 5 year, 3 year, 2 year and three month. The bigger the difference in the yields, the more stimulative for the economy it is. That difference is also one way to gauge how incentivized banks are to lend as they borrow on the short side of the curve and lend on the long side. The bigger the difference, the more banks may be willing to lend which is good for their economy and their profits.

Anyway, last week, the yield curve for shorter-term maturities inverted, meaning that the yield on the three year was higher than the five year. Prior to that, the yield curve was flat. You would have thought that someone literally flipped a switch to recession as it seemed like the whole world woke up to a short-term inverted yield curve and the economy was now in a tailspin. That’s beyond idiotic and nonsensical.

First, we only saw part of the yield curve invert. The 2/10 year yield curve which usually follows the 3/5 inverting hasn’t done so yet. Inverted yield curves do lead to recessions and it is an accurate predictor, however, it’s not like flipping a switch. There is usually several quarters to years of lag time before recession hits. And stocks typically perform well in the weeks and months after the 2/10 curve inverts which hasn’t even happened yet.

With so many negative forces in the markets today, it certainly has the look and feel of a solid bottom forming with major rally coming amid continuing volatile conditions. Sticking my neck out as I usually do, I would be surprised to see stocks fall off a cliff from here. Just below 24,000 should provide a floor for now.

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Lots of Sectors Resist Decline & Many Seasonal Stats Point Higher

The correction in stocks technically continued through last week although I remain firm in my opinion that this is all part of the bottoming process that began in October. With each passing week, more and more bulls turn to bears and I feel like I am almost alone in my forecast that new, all-time highs will be seen in 2019. While higher prices will be accompanied by unusually high volatility, I do not believe that a rising tide is going to lift all ships this time around. The number of haves and have nots should increase significantly.

As four of the five major stock market indices are right around new lows, I think it’s telling that the NASDAQ 100 is not and bucking the trend. Additionally, a whole host of sectors are following suit, lending more credibility to my position that stocks are bottoming not accelerating to the downside. They include semiconductors, software, telecom, internet, discretionary, homebuilders, materials, staples, utilities, REITs, healthcare and biotech.

Turning back to the correction and bottoming process, it has now gone from being a simple one based on price action to a more complex one, not unlike the decline we saw in Q1 of this year. By “simple”, I mean that the decline unfolded in one or two legs to the downside and wrapped up in less than two month. “Complex” declines tend to bounce up and down, up and down several times over a period of more than two months. They also tend to suck in more and more investors who believe the decline is the beginning of a bear market which every decade or so does happen.

One of the differences between this decline and the Q1 one is that it is very unusual to have this kind of weakness this late in the year with this level of volatility. One day declines in December of 3%, like we saw last week, have only occurred in 1987, 2000 and 2008. The first instance led to the immediate re-launching of the great bull market. The second and third were during very ugly and nasty bear markets.

Let me throw another stat or two at you. When the first 11 months of the year are up, as 2018 has been, December has been up 20 of the last 22 years. I think most of us would gladly accept a breakeven month at this point, let alone finishing in the black. Furthermore, as markettells.com points out, buying the first down week in December, like we had last week, almost always leads to a rally one to two weeks later. There are tons of other positive seasonal stats this time of year because it’s been one of the strongest seasonal tailwinds on record, especially in mid-term election years. So far, however, every single one of them is failing although there are still three weeks left in the year. Don’t count Santa out just yet!

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Ugly & Ugly

On Monday, I wrote about the fireworks I saw coming at the open and not to get sucked into the media’s and pundits’ hysteria. Smart money would be selling not buying.Well, frankly, I wish I did some selling into that bull trap as Tuesday was downright ugly and this morning is looking even uglier to begin the day. I definitely did not see a decline of this magnitude coming. As I always say with outsized opens, where stocks close matters a whole lot more than where stocks open.

I am just now picking this blog back up as I left the office with an intense migraine and needed a little quiet time. The first 90 minutes were pretty awful but stocks have been trying to stabilize ever since. Today has the possibility to be a low, but the close is a few hours away and that will be very telling.

Before this latest decline began, the stock market looked decent. It was in the repair process from the October correction. At this point, I have to stick with this all being part of the bottoming process I have been discussing. In fact, it’s looking more and more like a compressed version of how stocks traded in 1994 when the bond market was more difficult than today. In 1994, stocks bottomed on December 8 with the news of Orange County California filing for bankruptcy.

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Fireworks at the Open

No one was surprised that positive news came out of Trump’s meeting with Jinping over the weekend. That’s been his m.o. all along. And stocks are set to react in a big way, at least at the open, with the Dow looking up 400-500 points. After last week’s huge surge this just continues the dominance by the bulls as I have been writing about.

For the Dow, the next big hurdle to clear is closing above 26,300 which was the highest price in November. The other major indices have their own levels. I don’t think closing above those key areas will be accomplished today and perhaps not this even this week, but let’s wait and see how stocks close today before jumping to any conclusions.

Now is when real leadership should begin to emerge. We really need to see either the banks or the semis step up. Without one of them, I fear that Dow 27,000 will be a selling opportunity. On the positive front I am encouraged that the transports have cleared their highest point in November although their decline and price damage was on the more severe side, relatively speaking.

Get ready for some fireworks at the open, but don’t get sucked in by the media and nonsense from the pundits who could not have been more wrong about the correction, bottom and this rally. If investors weren’t smart enough to buy before today, they could look like idiots once again for chasing prices higher. I am glad I am not in that boat.

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Whining & Crying Over Interest Rates

After Wednesday’s huge surge, stocks were quietly digesting on Thursday, somewhat as you would expect. With the initial blastoff from the bottom over which typically lifts all ships, especially those that were hit the hardest, it’s now time to start stalking emerging leadership. I am going to reserve judgement at this point since, frankly, I do not have strong conviction other than the transports are one sector acting very well. I want to see what the defensive groups do over the next week or so.

What I find really shocking right now is how the masses and media refuse to talk about long-term interest rates. All we heard all year was about how high rates were going and how bad it was for the economy and markets. Every stock market decline brought out whining and cries about rates.

Meanwhile. if you look below, the yield on the 10-Year Treasury Note now stands at a 10 week low. Long-term rates have been coming down, down and down. But you don’t hear that anywhere because it doesn’t fit the narrative. Wait. Just wait for it. Next week, the media and pundits will be back to worries about the flattening yield curve (short-term rates versus long-term rates) since long-term rates have fallen so much. Commence whining and crying!

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Bulls Drive Ahead But More Stocks Down

The bulls did a nice job on Monday and Tuesday after laying an egg during Thanksgiving week. I don’t think Wednesday will be quite as easy during the afternoon. While the major stock market indices scored gains on Tuesday, there were almost 700 more stocks going down than up. That’s not exactly the pillar of strength which leads to immediate gains. Frankly, it’s a little disappointing.

The vast majority of our work turned positive at the end of last week so my scenarios will continue to have a bullish outcome. As I mentioned the other day and will continue to state, the worst case downside looks to be just under Dow 24,000 while the upside should be around 27,000. I will take that risk/reward ratio every single day.

Since the bottom last week, the lagging and pummeled NASDAQ 100 has been the index leader which is what normally happens in the embryonic stages of a rally. Sooner than later, the real leadership will emerge which very well may be the NASDAQ 100, however it’s too soon to tell. I am also not reading too much into sector leadership just yet nor the fact that high yield bonds look downright stinky.

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The Makings of the Bottom

Coming back from being out of the office for over a week is never easy although I received a few emails doubting I was actually away since I sent so many updates last week. It’s not that hard when your kids like to sleep in and you don’t. I got a lot done before any of them, including my wife, starting stirring in the morning.

Stocks came back from the Thanksgiving feast with the bulls firmly in charge early on. This is very unusual behavior as we would normally see strength last week and some give back today. When I ran my numbers and models over the weekend, I saw almost across the board strength and improvement in the face of lower prices last week. That may seem a bit counterintuitive. The stock market went down but my research became more positive. That’s exactly what happened. Prices went lower, but the internals of the market actually improved.

Look at the Dow with the Volatility Index (VIX) beneath it. The VIX spiked to its highest level in early October but has made a series of lower spikes, showing less downside momentum and ripe for a turn in the Dow.

Those conclusions don’t say anything about the next day or possibly week, but it does further confirm that the next significant move should higher as I have been stating for a few weeks. I think the risk/reward is strongly skewed to the upside by a factor of at least 3:1. Looking at the Dow, sure, prices could tick just below 24,000 or 2% lower, worst case. On the upside nothing has changed. Dow 27,000 should be seen in Q1 of 2019. That’s a 5:1 spread. Not bad if I am right.

Volatility is going to remain. Lots of repair work still needs to be done. The incredibly strong seasonals that everyone was quoting last month have fallen flat on their face. Investors have become fairly  negative. The news flow isn’t good. Between the Fed, Europe and tariffs, there much to worry about. All the ingredients for a stock market bottom are here.

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