“Key” Reversals. Junk Bonds Still Stink

Let’s start with junk bonds. While they don’t really stink, they are not participating at all in the stock rally. As I mention time and time again, that has little value in the short-term and no predictive power. However, it does matter, and sometimes a lot, over the intermediate-term. My fear, well I am really not scared but rather concerned, is that the final peak in high yield bonds has already been seen. If that’s the case, it doesn’t bode well for the bull market in stocks passed 2019 which would fit in with my thought of recession coming.

On the equity side, while stocks jumped out of the gate on Monday on temporary aversion of the trade war with China, the stock market certainly did  not trade well that day with no index closing at or near the high of the day. On Tuesday, we saw another one of those “key” reversals where stocks open at their highs for the day and close near their lows. It looks ugly on a chart as you can see below in the Russell 2000 Index of small caps which has been the leader. While stocks typically do see weakness after reversals, it’s nothing like the gloom and doom so many technical pundits call for after this one day pattern triggers.

A few of our short-term models turned negative on Monday and Tuesday so I am going to temper my enthusiasm for now. While I remain steadfast that fresh all-time highs are ahead above Dow 27,000, I think some caution is warranted here.

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Pause Ending?

With news out that Trump Tariff Tantrum has been delayed, stocks around the globe are rallying roughly 1%. That’s the expectation when trading begins for the new week. It will be telling to see if all five major stock market indices can score new highs for the month which would give the bulls more credibility. I would really like to see another index besides the Russell 2000 see all-time highs right now.

Additionally, on the far right side of the chart, it’s important for the former technology leader, NASDAQ 100, to at least keep pace on the upside if not lead outright. It will go a long way if this index can close above the light blue and dark blue lines which will set it on a course to all-time highs next month.

On the sector front, semis are doing “fine” but could be doing better. Banks seem poised to lead and score new 2018 highs before long. Ditto for discretionary. Transports, as I mentioned last week, look “juicy” and are also in a strong position to take off to the upside and lead stocks on an assault higher. As I continue to mention, only junk bonds give me cause for concern over the intermediate-term.

Stocks should move higher this week into the unofficial beginning of summer. If they do, I will watch to see if sentiment gets on the giddy side or if skepticism remains. That should tell us a lot about the rally’s duration.

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Small Caps Still Leading But…

The mild pullback/consolidation continues although you wouldn’t know from watching the Russell 2000 small cap index below. This index sits at all-time highs as seen above the dark blue horizontal line as well as breaking higher above the light blue line which has contained price since the early Q1 correction. On the surface things look really good for small caps as they are leading. However, I do think their leadership is close to ending with the other major indices about the step up.

Even beneath the surface with the NYSE A/D Line, things are just fine. Stocks should be insulated from any major carnage for a while. Only the continuing plight of junk bonds has me a little concerned. They just cannot seem to lift their heads at all. While that doesn’t mean much in the short-term, it does have implications the longer this behavior lasts.

I was planning on doing a post on the recent spike in bond yields, but that will have to wait until next week as I am way past my self imposed deadline on an important report to clients.

Have a great weekend.

Hoping that we get two straight days without rain sometime soon!

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Pause to Refresh. Transports Looking Juicy

It looks like Monday’s failure by the bulls put in a short-term peak and stocks will either trade sideways for a bit or pullback below Tuesday’s low. There shouldn’t be too much price deterioration. We have some overbought readings in the major indices so if stocks can resist much weakness, that could speak volumes about the next move which should be to new  highs.

On the key sector front, banks and discretionary are quietly stepping up while semis appear to need a rest. Transports may be the most interesting of the lot as this week was the fourth time they tried to get through 10,850 on that index. My sense is that on the fifth try, this key sector will blast through and head to new highs, perhaps in July or August.

The only significant concern I have now is the same one I have had, high yield bonds. They are not leading and barely rallying. While this behavior can sometimes warn falsely or even warn for more than a year, it’s something to keep front and center as my favorite canary in the coal mine.

In Friday’s piece, I will spend some time on the recent spike in yield on the 10 year Treasury note which has everyone’s attention.

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Nothing Sexy But Still Higher Prices

Since May 3rd, the path of least resistance has been up in the major stock market indices. That is supposed to continue although I will soon be on the lookout for a short-term pause or minor pullback. With the small cap Russell 2000 leading, there has been little to complain about lately, at least for the bulls. While none of the four key sectors are knocking it out of the park, they all look poised to head higher. Energy has been leading as is typically the case at the end of the cycle and bull market with high yield bonds being dragged higher and lagging as we normally see in the latter stages.

As I wrote about last week, the NYSE A/D Line is scoring all-time highs which typically insulates stocks from a bear market for 3 to 21 months. The gains may not be as sexy and sultry as they once were, but stocks remain the place to be over the intermediate-term. It’s time to temper expectations that a rising tide will lift all ships. I fully expect rallies to begin to become more selective.

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Bull Markets Do NOT End This Way

*NOTE: I began this piece as my regular Friday blog post as a follow up to a tweet I sent last night. The more I wrote, the more I wanted to say. That turned into more of an Analysis 101 piece which I am distributing to everyone. It’s also one very important piece in my canaries in the coal mine which I hope to have out next week.

One of my favorite long-term indicators scored an all-time high on Thursday, the New York Stock Exchange Advance/Decline Line (NYSE A/D Line). Before you stop reading, start yawning and move on to another topic, this is one of the better indicators of long-term health for the stock market. For those not familiar, every day, we look at the net number of stocks going up or down on the NYSE. If there are 2000 stocks up and 1000 stocks down, the net number is +1000. From there it’s just a cumulative line as you can see below.

The NYSE A/D Line is valuable because it tells you what’s going beneath the surface of the major stock market indices. Since most of the major indices are weighted by market capitalization or value, they can often mask underlying problems if the biggest stocks are doing fine.

Normal behavior over time shows that the NYSE A/D Line and the major indices like the S&P 500 generally move in the same direction with similar peaks and valleys. When the major stock market indices make new highs but the NYSE A/D Line does not, that’s where bulls should begin to worry. If you look at the chart above, the exact opposite is happening. The NYSE A/D Line is at all-time highs, but stocks are still well below those highs. That’s typically a good sign for further strength in stocks over the intermediate-term.

Bull markets usually end when the NYSE A/D Line peaks and rolls over to the downside long before the major stocks indices do. A good analogy would be that the generals are all still battling but the enlisted men have all died. Or, the foundation of the building is full of cracks and is crumbling but the penthouse looks flawless with million dollar art and furniture.

If you look at all of the bear markets since 1955, which I arbitrarily used as a 20% closing decline in the S&P 500 from an all-time high, you find 9 beginning on these dates:

8/3/1956

12/12/1961

2/9/1966

11/29/1968

1/11/1973

11/28/1980

8/25/1987

3/24/2000

10/9/2007

I could have also added 7/16/1990 and 7/17/1998 as those declines were just short of 20%, but it just adds more credence to the outcome. In every single case except for 1968, the NYSE A/D Line topped out before the S&P 500 although 1966 was only three weeks. 1990 and 1998 did as well. The average lead time was 221 market days or about 10.5 months.

Again, with the NYSE A/D Line scoring an all-time high, that has traditionally insulated stocks from a bear market for at least three months but as long as 21 months. It doesn’t mean that stocks can’t fully correct, but that weakness should definitely be bought. While the masses were exclaiming the end of the bull market during the February decline, I have pounded the table at every juncture that regardless of the decline, fresh all-time highs were coming, at least to Dow 27,000, partly because this indicator peaked with stocks in January as it usually does during healthy bull markets and has not yet diverged.

For those wondering, in 2007 as you can see below, the S&P 500 peaked in October, but the NYSE A/D Line topped out in June, a full four months lead time.

The previous bear market from 2000-2002 saw the NYSE A/D Line peak in mid-1998, a full 21 months before the major stock indices did as I show below. In fact, by the time the Dow, S&P 500 and NASDAQ 100 topped out in March 2000, the vast majority of stocks had already been declining for almost two years. If it wasn’t Dotcom and tech, it wasn’t going up.

While this is a very powerful long-term tool, it is certainly not foolproof nor infallible. It will give warnings that later get corrected without much of a decline in stocks. The NYSE A/D Line will decline as stocks go up, but then regather itself and make new highs down the road. That’s why I use it in conjunction with other tools or canaries in the coal mine.

Finally, naysayers like to argue that the NYSE A/D Line is full of too many non-operating companies which behave more like bonds and therefore the results get skewed. While they are correct, research concludes that including the bond-like proxies is a much better indication of overall stock market healthy than just using the NYSE A/D Line for common stocks only.

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Stock Market & Economy Yawn as Trump Terminates Iran Deal

I have to laugh when I hear so many pundits surprised that Trump withdrew from the Iran nuclear deal. It was one of his many campaign promises. Most members of his revolving door administration were squarely against the deal’s continuation. What was so surprising?

While my interview was 5 minutes, only a few comments made the segment on WTNH (ABC in CT) last night. I don’t think the Iran news will have any economic impact at all. It’s been fairly priced in the markets.

Oil had one of its most volatile days in years as you can see from the ETF that owns oil below. However, counterintuitively, oil did not rally sharply on the news that perhaps Iran won’t be able to sell all of their oil as they have been doing.

The truth is that oil has been rallying for two years from $26 to $70 as I have forecast a few times in my Fearless Forecast. $100 has been my upside target, but I do not believe it is going there during this rally. Oil is at the point where too many people finally believe in the rally. That’s usually the beginning of the end.

The major stock market indices are taking all of the geopolitical news in stride. Consolidation seems to be the operative word as stocks ready for an upside resolution. The S&P 400 and Russell 2000 have been behaving better than their cousins, but I can’t argue with any action over the past 5 days since I wrote about the green shoots.

 

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Friday was Constructive but More Work to be Done

Last Thursday, I wrote about green shoots in the stock market. Until former Fed chair Ben Bernanke used that phrase on 60 Minutes in March 2009, I had absolutely no idea what it meant. Later I learned that after a forest fire burns everything to the ground, the landscape becomes incredibly rich with nutrients and these little “green shoots” spring up as the first sign of new life. Eventually, these shoots become trees that grow very tall over time. Of course, Bernanke was referring to the economy at the very nadir of the financial crisis.

While the economy and markets saw nothing even remotely close to the 2007-2009 period, a number of my short-term indicators and investment models were sprouting green shoots last week. That was tough for me to reconcile as none of the concerns I have voiced for the past few months have been allayed. Nonetheless, the data are the data and they did push me back to being more positive on stocks, if only for a few weeks or a few months. We will have to see.

Friday’s stock market action was constructive. Semis and discretionary led. Index leadership was good. More than 80% of the shares traded on the day were in stocks that went up although I would really prefer to see a 90% day or two.

Finally, price remains in the middle of the recent range as seen below. Three months after the mini-waterfall decline, prices are still bound. You can see the blue horizontal line as well as the light blue down sloping line. While it will be late, having prices close above both lines should confirm the bulls are firmly in charge and stocks will be rallying to revisit the January 26 all-time peak. Let’s round up and call it 2720 or so on the S&P 500.

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Green Shoots for the Bulls After Fed Selloff

As expected by almost everyone, the Fed stood pat on Wednesday. I was shocked to hear some pundits predicted a rate hike. That’s one of the dumbest forecasts I have heard in an awfully long time as the Fed has become almost too transparent and too accommodating to the markets. A rate hike out of nowhere?!?! That made me laugh out loud. Stocks sold off after the announcement for the second straight Fed meeting, in direct contradiction to one of the Fed trends I write about. We’ll have to see going forward if that edge is being arbitraged away or just temporarily not working.

As I mentioned, stocks sold off yet again yesterday even though tech behemoth Apple saw very strong earnings. So much for the pundits’ smug comments about Apple leading stocks and record earnings insulating stocks from decline. The stock market continues to be under pressure, but there doesn’t seem like there is much urgency nor panic. That would be better for the intermediate-term. While I am starting to see some positive signs beneath the surface (green shoots???), I think it would be healthier for the bulls if the Dow could see a mini plunge towards 23,000.

Looking at risk/reward, it looks like Dow 23,000 on the downside with the reward being 27,000 over the next quarter or so. That favors the bulls, but it will certainly not feel so good if stocks fall to new 2018 lows first. None of the four key sectors are getting much love, especially semis. Neither are junk bonds. Leadership looks very narrow right now and really concentrated in commodities and energy. That doesn’t exactly warm the heart of the long-term bulls as this is classic late stage behavior and does warn that the next rally could be the last one in the 9 year old bull market. However, let’s not forget that the NYSE Advance/Decline Line recently made a new high, even if only by a whisker. That usually insulates stocks from a bear market for the next 3 to 21 months. In our case, I don’t think it will be the latter.

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***SPECIAL Fed Update – Fed’s Arrogance & Pomposity Leading to Recession Watch***

Stock Market Behavior Models for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Over the past few meetings, many of the strongest trends were muted.

As with most statement days, the model for the day calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. If the stock market opens outside of that range, there is a strong trend to see stocks move in the opposite direction until 2:00 PM. For example, if the Dow opens down 1%, the model says to buy at the open and hold until at least 2:00 PM.

With stocks somewhat on the defensive lately, the next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 80%+, but it would have been stronger in magnitude had Tuesday’s early weakness not been overcome. Last meeting, this trend did not work as early strength on Fed day was sold in to and then piled on.

Rate Hike – One Down, Three to Go

The Fed is going to take no action today. At best, their commentary will be benign. At worst, Powell and company will upgrade their economic forecast which will also increase the likelihood for three or even four more rate hikes this year. June becomes the “live” meeting where rates should go up by another 1/4%. Then September and December. Back in January, I forecast 3.5 rate hikes this year with the risk to the upside. I am standing by that.

To reiterate what I have said for more than a year but a little more bluntly, the Fed is misguided, arrogant and in desperate need of help. NEVER before have they sold balance sheet holdings in the open market AND raised interest rates. In fact, I don’t think it’s ever been done in the world before. So why on earth do they believe they will so easily be successful? This grand experiment is going to end poorly and we are all going to suffer at the hands of the next recession which I stabbed in the dark as beginning between mid 2019 and mid 2020.

Yes, with banks holding $2.5 trillion on their balance sheets, the recession should be mild and look nothing like 2007-2009. And yes, this expansion will be more than 10 years old. And yes, there will be some external trigger like 9-11 or the S&L Crisis to push the economy over. But the Fed will have greased the skids sufficiently for the economy to recess.

Let’s remember that the Fed was asleep at the wheel before the 1987 crash. In fact, Alan Greenspan, one of the worst Fed chairs of all-time, actually raised interest rates just before that fateful day, stepping on the throat of liquidity and turning a routine bull market correction into a 30% bear market and crash. In 1998 before Russia defaulted on her debt and Long Term Capital almost took down the entire financial system, the Fed was raising rates again. Just after the Dotcom Bubble burst in March 2000, ole Alan started hiking rates in May 2000. And let’s not even go to 2007 where Ben Bernanke whom I view as one of the greats, proclaimed that there would be no contagion from the sub prime mortgage collapse.

Yes. The Fed needs to stop.

Velocity of Money Most Important

Below is a chart I have shown at least quarterly since 2008. With the exception of a brief period from mid 2009 to mid 2010, the velocity of money collapsed. It’s still too early to conclude, but it does look like it stopped going down in 2017 and might be just slightly starting to turn up. If 2017 does turn out to be the bottom, this could could eventually lead to the commodity boom I see for the 2020s, especially ex energy.

In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a disastrous bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. The economy has been suffering for many years and will not fully recover and function normally until money velocity rallies. This is one chart the Fed should be focused on all of the time.

It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets. It continues to boggle my mind why no one called the Fed out on this and certainly not Yellen at her quarterly press conferences. Hopefully, someone will question Chairman Powell on this next month.

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