Don’t Get Fooled by Negative Nonsense

After an ugly opening stocks scratched and clawed to cut their losses on Tuesday, something I did not expect to happen. The bulls’ strength was impressive. I was hoping to see some follow through on Wednesday, but that did not materialize. The Dow Industrials remain the weakest index followed by the S&P 500, S&P 400, NASDAQ 100 and Russell 2000. I was clearly wrong in the glimmer of hope the value sector gave for new leadership. Their leadership will one day come, but not the past few weeks.

From a long-term perspective, the NYSE A/D Line continues to look strong and insulate stocks from a bear market, for now. Plainly put, we are seeing good participation in the rally.

And as I have mentioned over the past few weeks, junk bonds no longer stink. And believe it or now, they are even exhibiting some leadership characteristics.

While TV and the internet may be overwhelmed with negative commentary, things are just fine in the economy and markets. Don’t let the habitually wrong crowd fool you. The bull market remains alive and headed to 27,000 next quarter.

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Bulls on Their Heels, Unlikely Enough Strength to Muster a Stand

The bulls mustered enough strength on Monday to avoid closing anywhere near last week’s lows. That was mildly impressive. However, the Trump Tariff Tantrum is front and center today as it was on Monday as overnight action looks like a nasty 300+ point decline to begin Tuesday. Unlike yesterday, I will be surprised if the bulls have enough power and ammunition left to thwart the bears.

Taking somewhat of a stab in the dark, I would imagine a day where stocks open sharply lower, bounce for an hour or so, establish a range and then sell off again after lunch. If the morning lows are broken, there is potential to see a large down day, somewhere between 500 and 800 points. Obviously, there’s a lot of hyper short-term speculation in there. Again, the bulls would really surprise me if they had enough power to hold the decline to under 150 points on the Dow.

I mentioned bonds on Monday and it will be interesting to see if they have enough strength to trade above last week’s high. Yesterday’s action was not that great. IF they can get moving, it’s not out of the question to see the 10 year note yield below 2.80%.

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Trump Tariff Tantrum Again

Stocks came back from some mild morning weakness on Friday but still look like they want to pause to refresh as the on again, off again continuation of the Trump Tariff Tantrum is front page now. In the very short-term, it’s pretty easy. Closing above last week’s highs gives the bulls energy to move higher. Closing below Friday’s low means stocks could see a mild 2-3% pullback before heading to all-time highs in Q3. The seasonal trends show some weakness ahead as it is the week after option expiration with stocks in an uptrend. I believe the hat tip goes to Rob Hanna of Quantifiable Edges but I am not 100% sure.

While banks have pulled back and need to stabilize, semis are still okay but really need new highs. I keep writing about transports as they look like the next major sector to take off and lead. That’s still the case as they seem poised to run to new highs.

Bonds on the other hand, look like they have a little life, especially if they close above Friday’s high. The more the masses have become aware that rates have gone up so dramatically in absolute terms, the more I have been positive on bonds. While I continue to believe that the 35-year bull market in bonds ended in July 2016, there will be plenty of opportunities on the long side over the coming years and decades. It’s just like with stocks. While they have gone up, up, up for more than 9 years, they have been plenty of times to position for a move in the other direction.

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Bears May Have Reason to Celebrate But It Will Be Short-Lived

On Wednesday with most of our tried and true Fed Day trends muted, I mentioned the possibility for a negative set up. With the S&P 500 down on statement day, that set up a shorting opportunity for yesterday, today and into next week. Nothing big, just some potential mild weakness after a very nice run into the Fed meeting.

If any weakness does materialize, it will be interesting to see if tech cedes leadership in favor of value. With the NASDAQ 100 it certainly doesn’t appear that way and my call for a change in leadership in favor of value does seem a premature and a bit foolish. Speaking of the NASDAQ 100, I am a little  bothered that semis remain below their highs. That needs to be watched closely for signs of a more serious divergence and warning. Investors have been more focused on software and internet which is okay in the short-term.

Looking at the other three key sectors, banks remain mired in a trading which I continue to believe will resolve itself to the upside next quarter. Transports have been strong and leading and should also see all-time highs next quarter. Consumer Discretionary has been the strongest leader over the past 6 weeks, but I would imagine the upside acceleration begins to slow sooner than later.

Finally, as I started to mention late last week, high yield bonds no longer stink. They have been kicking it up a notch of late, but still remain nowhere near their 2017 highs.

The bottom line. Any short-term weakness should be bought.


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Canaries in the Coal Mine Part III – The Others

The final group of canaries don’t have anything in common. I just grouped them together to avoid having three more small canaries. Let’s start with high yield (junk) bonds which I write about very often on the blog. I like to use one of the exchange traded funds (ETF) ones as well as one from the mutual fund space.
Right below, you can see JNK which is one of the two major high yield bond ETFs. It peaked in early January. Just below that chart, you will find PHYDX which is a PIMCO’s giant high yield mutual fund. It, too, peaked in early January which is technically not so bad, however I am very concerned about the depth of the decline that ensued and high yield’s inability to rally very much since. While I do think high yield will rally this month and into Q3, I believe there is a good chance that the January peak for this all-important canary could mark the bull market high. If that’s the case, the stock market will have lost an important canary for quarters or perhaps even years to come.

The New York Stock Exchange Advance/Decline Line (NYAD) is next and it is important because it shows the levels of participation in the bull market rally. 90% of all bull markets deaths show a NYAD canary that was dead at least three months before prices started to roll over. In other words, the NYAD is a very good leading indicator that will sometimes give false warnings, but rarely fail to warn. It usually pays to watch for times when stocks are making new highs and this indicator is not.
Below you can see that at the January peak, the NYAD was scoring fresh new highs. As has been the theme of this whole issue, this is absolutely not the type of behavior usually seen at bull market peaks.
Finally, somewhat similar to the NYAD, we look at the percent of stocks above their average price of the last 200 days. Bull market typically end with significant weakness beneath the surface over the long-term. That means the line below should be going down well before price see their final highs and the number should certainly be less than 60%. At the January stock market peak, 75% of stocks were trading above their 200 day long-term trend.
Summing it all up, as has been the case during every single stock market pullback and correction since the bull market launched in March 2009, the bearish pundits have been dead wrong. The preponderance of the evidence strongly suggests new highs for the stock market which I have been forecasting all year, above Dow 27,000. I still have an upside projection to Dow 30,000.

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Canaries in the Coal Mine Part II – Sectors

Let’s turn to the next group of canaries and see how our sectors were doing at the January peak. First, I am repeating the Dow Industrials with the Dow Transports right below it to show Dow Theory which says that these two indices should be making highs together or a warning is sent. While both indices saw all-time highs in January, you may observe that they were on the same day or even week. That would not be a warning or cause for concern unless more time elapsed in between.
Seeing that the Dow Transports did make an all-time high in January, let’s turn to the other key sector canaries. As you can see below, the banks, semiconductors and consumer discretionary all made new highs in January. Again, this is absolutely not the type of behavior typically seen at the end of bull markets.

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Canaries in the Coal Mine Part I – Indices

Canaries in the coal mine is always a vitally important issue for me to write as it speaks to the long-term, especially when it comes to the risk of a bear market. In 2018, since stocks corrected 12% in February, I have boldly, firmly and confidently stated on CNBC, on Fox Business, on Yahoo Finance, on all local stations in CT and almost every week on the blog that the bull market which began in March 2009 remains alive and well, albeit somewhat old and wrinkly. Stocks would recover from Dow 23,500 and head to 27,000 in Q3 with 30,000 not out of the question this year.

While pundit after pundit offered very differing opinions, sometimes challenging my “perma bull” stance, I refused to cede any ground. Bull markets have never, ever ended with the behavior seen at the last all-time high on January 26, 2018. Of course, I could be wrong, a precedent set and have egg and losses all over my face. However, the odds would say that is a long shot.

As an aside, I always chuckle when people label me “perma bull” or “perma bear”. If anything, I am a perma opportunist, using the data at hand to guide me. For years, one of my friend’s fathers who sells financial and insurance products for Ameriprise would always tell me that I was too negative. He would tell me to just buy “good stuff” and don’t worry. That “good stuff” were those high flying Dotcom stocks and the years were 1999-2001.
Back to the canaries. For newer readers, this issue is only relevant and valuable to gauge whether a bull market is in jeopardy of ending. As such, prices must be at new highs or rolled over from new highs. Canaries say absolutely nothing 5%, 10%, 15% or even 20% bull market declines. This analysis will not be useful in forecasting those declines.
With all of that out of the way, let’s dive in. The canaries issue is full of charts so it will print a lot longer than any normal issue with a lot less text from me. The idea behind canaries in the coal mine is that bull markets do not die all at once. It’s a process. Canaries begin to die long before the public realizes that a bear market is coming, sometimes as long as 24 months in advance. It puts on warning and cautions us against taking on even more risk.
Let’s start with the five major stock market indices. At bull market peaks, we would not see all indices scoring new highs together. One, two or even three indices would fall short. Below, you can see that all five major indices scored all-time highs in sync in January. That is very strong behavior and absolutely not what you would normally see at the end of a bull market.

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***SPECIAL Fed Update – Continued Arrogance & Pomposity Spells Recession***

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 and today is no different.

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  rallying strongly and closing at the highest level in more than 50 days, the usual post 2:00 PM rally has been reduced to slightly more than a coin flip, not exactly the big edge we are used to trading. However, with this strength, an opportunity for a decline opens up depending on how stocks close today.

Second Rate Hike of 2018  Today

The Fed is going to raise the Federal Funds Rate by 0.25% today. That’s almost 100% certain. Markets will be paying very close attention to the statement and Q&A from Chairman Jay Powell to glean what’s on their mind the rest of the year. With the usual Q1 sub-par GDP growth out of the way, Q2 and Q3 look to be much stronger. Additionally, May inflation numbers came in a little hot on both the consumer (CPI) and producer (PPI) side. With the PPI outpacing the CPI, companies are not able to fully pass along price increases to the consumer which is good for the consumer but not so good for companies who will see their margins squeezed somewhat. In turn, this could put some pressure on earnings down the road.

Back in January, I forecast 3.5 rate hikes this year with the risk to the upside. I am standing by that and I haven’t wavered for even a day when the pundits were out in full force during the February stock market decline cutting their rate hike forecasts to just one more in 2018. That’s the problem with the vast majority of analysts; they focus too much on what is currently happening and lose sight of the intermediate-term and the big picture. Then, they get amnesia and revise history to never be wrong. I have never had a problem standing by forecasts, even when I end up being wrong. It’s all part of the business. Some I get with precision accuracy while others I have fallen flat on my face. Get up, move on and learn.

Anyway, the likely scenario is another hike in September as well as December where I look for the Fed to begin patting themselves on the back for a job well done.

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 as you can see on the second chart of M2V since 2008. If 2017 does turn out to be the bottom, this would also coincide with the bottom of the commodity cycle which I have discussed and should lead to a massive commodity boom over the coming decade, especially in the non-energy products.

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.

These two charts definitely speak 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 today.

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Leadership A Changin’

Stocks appear to be shrugging off the reversal I wrote about last week, pretty much as expected. There is a lot of the news docket this week with the Fed meeting on Tuesday and Wednesday as well as the summit in Singapore with North Korea. While the latter will be all the focus, the former has a much better chance of moving the markets. You should expect another special Fed edition shortly.

Over the past week or so, index leadership in the stock market has been showing signs of changing. While the Dow has been lagging for most of the year, it is perking up in the short-term and it is now rated number one against the S&P 500, S&P 400, Russell 200 and NASDAQ 100. After that, the S&P 500 and S&P 400 are essentially tied with Russell 2000 and NASDAQ 100 bringing up the rear. This probably comes as a surprise since the last two ranked indices have been leading the rally and the Dow has performed the worst.

Getting a little more granular, value stocks seem to be finally attracting some interest over growth. It’s been a long, long time with large cap looking slightly better than mid cap. Could the FAANGs be losing a little luster?!?!

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ANOTHER Reversal

While stocks opened higher on Thursday, the bulls couldn’t hold on to those gains as the Trump Tariff & Trade Tantrum sprouted up again. With the G7 meeting this weekend, stocks are probably going to pause and let tensions cool off. As headlines and tweets crossed the wires, stocks gave up those early gains and for a few hours, selling was strong.

Below is a chart that has become all too familiar. It’s the Russell 2000 Index of small cap companies and it shows all of the “key” reversals this year which are marked by stocks rallying early and then selling off into the close. Technicians often fret over these as they are usually seen before corrections set in. However, they are also seen many, many other times without much downside follow through.

Stocks have had a nice run. Any small pullback or pause would probably be healthy. The bull market isn’t over and Dow 27,000 is in sight for Q3. Remember, the S&P 400, Russell 2000 and NASDAQ 100 have all made new highs. Just the Dow and S&P 500 are remaining. The market is quietly strong and there has been little fanfare, especially from the media. I expect that to change when the two lagging indexes make new highs.

And even junk bonds are perking up a little…

Have a fun and safe weekend! Little League playoffs tonight. Practice tomorrow assuming we win. High school softball state championship on Saturday. Baseball double header on Sunday plus the usual errands.

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