As Expected, Pullback Continues

All month I have been writing about a short-term pullback for stocks. Nothing huge. Just your garden variety 3-5% bout of weakness which could overshoot. This coming from someone who has been bullish all year on stocks. I won’t reanalyze what I have already written several times, but here are a few reasons. The Dow Industrials were off on their own island of strength while the mid and small caps were in decline. Dow Transports were even weaker. Sentiment surveys and option data had become too greedy, too complacent and too positive. The list of stocks making new 52 week lows expanded and then surpassed those making 52 week highs, all while the major indices were so close to all-time highs. Key sector leadership fell off.

The stock market was just looking for a catalyst or an excuse to pull back.

First it was North Korea and then it was Charlottesville and now it’s Barcelona and Gary Cohn. The common thread in each case is President Trump. Since the post-election rally, dubbed the “Trump Rally”, “Trump Jump” and “Trump Bump”, I have remained firm that while the president always gets credit and blame, the rally was really based on the GOP’s election sweep and perceived ability to govern and pass legislation as they saw fit. That agenda is now being questioned and you will likely start hearing the media and pundits refer to the pullback as the “Trump Slump” or “Trump Dump”.

You don’t read this blog to hear my social views so I am not going to a rant about what’s going on in the country today. Suffice it to say that for as long as I can remember back to my childhood, I have always fought and stood against racism, bigotry, intolerance, discrimination, hatred and evil. They have no place in this country or on earth. There are no exceptions to this. At the same time, free speech is one of those inalienable rights which we often take for granted. However, it’s not really 100% free speech as you can’t scream “fire” in a crowded theater. There are limitations. Those a lot smarter than me will likely be struggling with this over the coming years if the 9-year escalation of racism, bigotry, hatred, white supremacy & neo-nazism continues.

That was more than I wanted to write, but it wasn’t quite a rant. Anyway, back to the markets and what’s at hand. The pullback is continuing as planned with Thursday being the first across the board rout where basically everything went down. For those looking for a silver lining, the defensive groups like staples, utilities and REITs were hit along with the others. That typically confirms the decline and indicates more downside before a low, but it’s getting there. It’s a necessary piece towards an eventual market bottom.

On the positive side, while high yield bonds have declined, their weakness has been small although I sense more downside is coming. The semis which I wrote negatively about here have been the quiet winners during the pullback and are the lone holdout from making new lows. It will be very interesting and telling to see if they can hold up.

With all of the major indices in gear to the downside, it’s unlikely that the current action is just a re-test of the North Korea decline from last year. Momentum is making a fresh low now so we are likely to see at least a low, a rally and a new low before the whole decline wraps up. I had written about a rocky period into mid-September and I am not ready to change that opinion just yet. Let’s see what shakes here. Don’t forget that the Fed has their annual retreat next week in Jackson Hole WY. With Janet Yellen and Mario Draghi (ECB) both in attendance, we should expect to hear more about their respective balance sheets.

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Market Like 1987 Again?

With Thursday being a downside rout that closed near the low for the day, stocks normally see two way action during the next morning before the opportunity for a stronger move comes after lunch. When markets are in the throes of a decline and I would hesitate to call this a decline of significance at this point, many of us turn to history for price analogs. The crash of 1987 really began to unravel the week before which was options expiration week.

Downside momentum kept building from Wednesday’s open and Friday was a disaster. Stocks crashed on Monday as a confluence of events unfolded not limited to newly appointed Fed Chair,Alan Greenspan, raising rates too quickly, Treasury Secretary James Baker announcing that the U.S. would not defend the dollar and this new, cutting edge institutional risk management program called portfolio insurance which essentially sold more S&P 500 futures the lower stock prices went. And the lower stock prices went, the more contracts that were sold. It was a snowball or pile on effect, much like the Flash Crashes of 2010 and 2015. Anyway, I bring this up not because I think stocks are going to crash 20% on Monday. I don’t. It’s just an interesting tidbit which you may hear about in the media, especially from the gloom and doom crowd.

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Energy Collapse. An Opportunity?

Stocks continue to bounce after the tensions with North Korea have quieted for now. As I have written about before, I think the stock market used North Korea as its catalyst or excuse to pullback. The underpinnings were a little weak and a little decline was coming regardless. My thoughts remain the same that the pullback is not over and the major indices will need to step it up sooner than later to revisit the old highs.

Every now and then I have mentioned the energy sector this year as it has been under what seems to be constant pressure all year. A few times, I saw short-term opportunities that never transformed into anything more. With this latest bout of selling the sector is once again approaching a window of opportunity. I say “approaching” as the opportunity is not here. I think we need to see the baby thrown out with the bathwater so to speak. It would be great for that to coincide with a piece of particularly bad news for the sector. You know. The things that bottoms are made of.

For now, let’s just watch the XLE ETF day to day and see if the opportunity sets up in a way where risk can be defined. It’s unlikely that it will quietly find a low with this kind of carnage.

Tomorrow, we will look at how crude oil is trading vis a vis the the energy stocks.

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Big Day for the Bulls But No All Clear Yet

Stocks bounced very strongly on Monday led by banks, semis and transports which just happen to be three out of four of my key sectors. That’s one for the bulls. The beaten down Russell 2000 index of small caps led the major indices higher and that’s another good sign for the bulls as the Dow Industrials definitely lagged the rally. While participation was decent, the number of stocks hitting new highs and new lows was not encouraging as they were almost equal. That’s one for the bears.

Given that all five of the major indices closed above last Thursday’s high, the rally should continue today, at least until lunch. High yield bonds did not have a stellar day on Monday and they are supposed to step up today. “Supposed” to is the operative word.

I do expect the bears to put up a fight before new highs are seen. That little battle will certainly go a long way into concluding whether my call for the pullback to continue is right or wrong. I also believe that tensions with North Korea are on simmer and will reignite over the coming month.

I tweeted about the Dow Transports on Monday which you can see below. This is not a new chart. I have been discussing it for the past few weeks as potentially a leading indicator for stocks. This sector was the first to exhibit weakness and then test the blue line which is its long-term trend, aka the 200 moving average. At the end of last week, the transports once again revisited its long-term trend and tried to reverse. On Monday, the group powered higher and confirmed a bottom of potential significance is in place. The upside target for this move is 9600.

The interesting “tell” will be if the rally fails in the transports and closes below the Q3 lows. At that point, we will watch to see if any other indices follow suit.

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Stocks to Bounce But Pullback Not Over

In part II of the piece I started last Friday, I turn to the market evidence supporting the 3-5% pullback I have been discussing all month. While tensions with North Korea have quieted down over the weekend and global stocks are sharply higher, I do not believe the pullback is over. Now, if the five major indices scream right back to new highs and sector leadership is strong, I will clearly be wrong in this call, but I am willing to give it some time. Let’s see if the bulls can first retrace what they lost last Thursday.

One of the many reasons I started looking for a pullback can be seen in the charts below. Just take a cursory glance and you will see that the Dow Industrials are leading the parade with the S&P 500 just behind. The S&P 400 and Russell 2000 are lagging significantly. The NASDAQ 100 is just a tad better.

Leadership by the Dow does not equate to healthy and strong leadership. It’s exact opposite. Investors are looking to hide in the “safer” and more liquid areas. If this was one of my regular Canaries in the Coal Mine update, I would offer that none have died or are close to dying, but a few are coughing.

Stock market sentiment began to get a little too happy, complacent, greedy or whatever other adjective you want to use. We saw it in the surveys, the options data as well as the Rydex fund flows. While sentiment ebbs and flows at a good pace, weakness is likely needed to restore at least a small wall of worry.

The semiconductors are one of my favorite sector canaries and concern over the past few weeks has been that with the NASDAQ 100, software and internet sectors all scoring fresh new highs, the semis have been unable to. If they started to rollover, they would likely bring down the rest of the tech sector with them.

The Dow Transports are another sector which had been under pressure long before North Korea became a recent issue. You can see below its decline was more than just a few day event and warrants attention.

Until earlier this week, I was holding out hope for the bulls by the continued strength in the high yield bond sector, my favorite canary in the coal mine. However, the past three days have seen relentless selling in this sector. Something has changed in the character of the market.

I could add to my list of short-term concerns including the infamous Hinderburg warning which really just says the market is very split with an equal number of stocks doing well as poorly. The number of stocks making new highs and new lows has shifted significantly to the negative over the past week adding credence to the Hinderburg.

HOWEVER (isn’t there always), the New York Stock Exchange Advance/Decline Line, which measures market participation just hit an all-time high earlier this month. Historically, that pretty much insulates stocks from a serious decline or bear market as it shows good health and lots of liquidity.

Finally, the much talked about VIX which is a broken measure of anticipated volatility spiked by almost 50% this week and almost 100% from its recent low. That has been a strong indication of future gains several months out.

In short, the next few weeks to month or so could be rocky, but not cataclysmic. Besides North Korea, we have the single biggest geopolitical since 9/11 on September 24th with the German election. Stocks are wounded and need some time to heal, but more new highs are in store later this year and into 2018. If you are nimble enough, selling short-term strength is the right strategy until proven otherwise.

As hard as it may be, investors would be best served by not being glued to the news channels 24/7. Focus on the long-term. The economy’s growth is accelerating. More jobs are being created. Record earnings. Heed my theme of 2017. Reality over rhetoric!

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North Korea was the Excuse

While North Korea is now front and center in the mainstream news as well as the financial news and the financial markets are now fixated on North Korea, the stock market was already positioned to retreat for the past few weeks. It was just looking for a catalyst. I started writing about the likelihood of a pullback beginning in late July as you can read, HERE, HERE, HERE and HERE. As you know, I have been resoundingly bullish all year and targeted Dow 23,000 by Q4 which I pushed back to Q1 2018. This is not the case of a bear who has been wrong just getting louder. It’s the most negative I have been all year although as you will read, I am still not calling for anything dramatic on the downside.

Historically, I have pretty much dismissed saber rattling as a one or two day market event where the markets quickly resume their prior trends. That’s been especially true of North Korea as it seemed like they just wanted world attention. The exception was Iraq in 2003 as it became clear it was only a matter of time before the bombs started flying.

Having been in the business for 29 years this month, I have learned enough to fill an entire Encyclopedia Brittanica series. In the late 1990s, I learned a valuable lesson about using 4 very dirty little words. “This time is different.” It rarely is. Regardless of the technology or societal advances, human behavior just doesn’t change. Markets oscillate between fear and greed. Regarding North Korea, I do not have the same feeling as I have had in the past. I know. I know. Feel is not real.

Russia and China both voted with the U.S. and the rest of the UN’s security council on the sanctions. That may not seem important, but remember, Russia occupied North Korea after the war and China was an ally during the war. Until the Soviet Union fell, Russia was North Korea’s protective big brother. In recent times, China has been North Korea’s quiet trading partner. Having both of them vote against North Korea, this is a huge sea change.

Additionally, I have heard through my channels that both Russia and China have amassed and continue to build through troop strength along their borders with North Korea. This is not normal activity and leads me to believe that Russia and China no longer think that Kim is just playing childish games. The two countries are preparing for something militarily. Whether that’s defensive or offensive remains to be seen. I do think that any unprovoked military action by Kim will be responded to very harshly by the U.S., Russia and China. If I lived in South Korea, I would be very worried right now.

I also think that whatever is going to happen with this current incident, it’s happening right now, meaning we are in it already. It could end this weekend with some kind of back door deal or it could escalate over the coming days and weeks. It will be interesting to see how President Trump handles all this. Is he combating a bully by pushing back or is he serious about action? Bluffing? Looking to make a deal? I have always thought of Trump as someone who beat his chest to scare and intimidate, but back down when push came to shove. We will see…

Back to the markets, before North Korea was on the markets’ radar screen, I discussed a number of short-term concerns. Before I get into them, my intermediate and long-term views remain absolutely the same. The bull market is alive and reasonably healthy for being 8+ years old. My next upside target is 23,000 by Q1 2018.

With that out of the way, my short-term worries lead to me conclude that a normal 3-5% pullback is underway. Of course, stocks could overshoot a few more percent, but I do not believe the stock market is in the early stages or approaching a 10%+ correction. The downside risk looks to be over the next month or so.

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Short-Term Pullback in Motion

Over the past week or so, I have gone from a trading range view with perhaps a slightly upward bias to a mild pullback of 3-5%. That’s where I stand today. Stocks sold off very hard on a relative basis from noon to the close on Tuesday as the saber rattling between the U.S. and North Korea continued. President Trump kicked it up a notch.

Regardless of the news, the markets were already in a position to pullback as I outlined in the past few posts. This should not be a huge deal, but it’s one where I am going to be a bit more vigilant than at any time this year. Perhaps a little pruning, hedging or even some sales as multi-year highs were rejected in the Dow and S&P with the mids and smalls doing even worse. Even high yield bonds had their worst day since early July. At the same time, defensive sectors like utilities and consumer staples behaved very well.

Again, I am not looking for anything substantial, especially since we are not seeing the internals collapse or across the board selling. This just looks like your plain vanilla bull market pullback.

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Economy Good. Markets Less So.

On Friday, the Department of Labor reported that the economy created 209,000 new jobs, which was 26,000 better than expected. The unemployment rate fell to 4.3%, the lowest level in 16 years. This is just another statistic that supports my thesis that economy is in better shape than the masses realize. You wouldn’t conclude this if you spent your day watching TV. Reality over rhetoric. I don’t care if this is coincidental, Trump’s doing or lack of doing or Congress. It’s irrelevant who deserves the credit.

And if you don’t like pouring over economic reports, just look at the stock market for a report on the economy. While imperfect, it does a great job at leading the economy. The problem is that the market sometimes gives warnings which don’t lead to recession. The old joke is that the stock market has predicted 7 of the last 4 recessions. However, it doesn’t miss recessions.

Turning to the markets, while the Dow continues to make new high after new high and the S&P 500 is close to a fresh high, the mid and small caps are several percent below their highs with the NASDAQ 100 somewhere in between. Sentiment is a bit on the excited side, especially with the media and pundits celebrating Dow 22,000. Semis and transports are lagging. However, high yield bonds and the NYSE A/D Line are just below all-time highs and behaving very well.

Again, I am not looking for anything more than a 3-5% bout of weakness during a seasonally weak time of year although with stocks so close to their highs, the negative seasonality should be somewhat muted. I don’t think this is the time commit fresh money.

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Growing Concerns

As the title suggests, I am more worried now than I have been in a while, however, it needs to be taken in context. I really haven’t worried at all lately and I absolutely do not believe the bull market is over or close to being over. I don’t even believe the stock market is starting a 10%+ correction. My theme of late has been that of a trading range environment, but I now think that it may morph into a 3-5% pullback. Stocks are long overdue for some weakness and it should be healthy.

Last week, I discussed the Dow Transport and semiconductors as two reasons to give pause here. Neither situation has been corrected although the former is testing its 200 day moving average or long-term trend. The latter continues to bother me. There are now more issues. Apple reported another blow out quarter of earnings and said all of the right things. On the surface, that should be celebrated, however, many times when stocks have rallied and a high profile company blows out, the stock market often suffers over the short-term.

The sentiment surveys and option traders are showing a little too much confidence and complacency right now. It’s rare that stocks just continue unabated. The Dow Industrials are scoring new high after new high, yet the S&P 400 and Russell 2000 are moving in the opposite direction.

Those are just a few concerns I have, not to mention the previous overwhelming fascination with Amazon although Bezos’ reign as the world’s richest man was certainly short-lived.

Again, I am not calling for anything spectacular on the downside and it may only manifest itself in the continuation of the trading range. But the evidence is growing that weakness is on the way.

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Q2 GDP Frustrates Bears. Bezos Still Rich?

The government released its first look at Q2 economic output and the economy grew by 2.6% at first glance. While I would have been happier with more, it’s the second straight quarter that seems to be falling in line with my forecast. Earlier this year, I offered that Q1 GDP would come weak and below expectations with Q2 much stronger. That’s certainly the case today. I am also looking at Q3 to be stronger than Q2 with a shot at eclipsing the 3% mark. That won’t be easy. My forecasts were based on widespread deregulation and tax reform. While the former has been happening quickly but quietly, the latter isn’t even being discussed yet, a huge mistake in my opinion. I still believe tax reform is more than a 90% certainty, but it likely won’t have a positive impact on our economy until 2018.

All week long, the media fell over themselves, gushing that Amazon CEO, Jeff Bezos, was now the richest man on earth. As is often the case when something becomes so widely accepted or loved, the opposite happens. Amazon quickly gave back all of this week’s gains on a less than stellar earnings report. Classic buy the rumor, sell the news.

The tech sector, mid caps and small caps all saw reversals to the downside this week as all of the major stock market indices poked to new highs at the top of the trading range I have been discussing for a while. It’s likely that a pullback has begun and some mild weakness will ensue.

The two things that concern me most are below. First, I mentioned that semis need to make all-time highs as their software and internet cousins have. Rolling over first will definitely bother me.

Second, the Dow Transports are very quietly down 5% from the July peak. This bellwether index has definitely marched to its own tune for several years,  but I would still rather see it behaving a whole lot better. Thankfully, junk bonds continue to act well and confirm the new highs.

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