Italy Definitely Matters. Canary in the Coal Mine?

Stocks were “supposed” to rally on Friday ahead of the long weekend. While they did put in a good performance, they still ended in the red. That adds further weight on the short-term negativity of some of our models when stocks don’t behave as the odds say they should.

This morning we woke up to more troubles in Italy. Anyone surprised by this hasn’t been paying attention. In my year-end report to clients as well as in my Fearless Forecast, I listed Italian and Spanish banks as things that will keep me up at night in 2018. Too big to fail, too big to save. I think this remains on the tip of the iceberg. Investors should worry a whole lot more about European banks than anything Trump is going to tweet and saber rattle.

Although I do not think this is anything like the financial crisis and 2007-2009, I do think these banks may be a canary in the coal mine. Remember sub prime loans in early 2007? How about those two Bear Stearns mortgage hedge funds that blew up in July 2007?

Early in the year, you were hard pressed to find many pundits who didn’t think Europe offered better risk/reward than the U.S. And most believed that European banks had much more upside than U.S. banks. While I couldn’t argue with their fundamental conclusions, I also couldn’t join the overwhelming majority in these trades.

Anyway, stocks look to open almost one percent lower, taking their cue from European markets. I wouldn’t read so much into it until we get past the first hour. We have upside and downside reversals still in play. Let’s see if which gets closed above or below first. The NASDAQ 100 and technology are poised to resume leadership as I mentioned last week.

Semis and internet look like they want to break out higher. The same with transports and discretionary. We will have to see about the banks. Energy stocks are oversold in the short-term. They are “supposed” to find a low this week. Junk bonds still stink.

Bonds continue to quietly rally which means lower rates. What happened to all of the bond armageddon pundits who drew all of those absolute and fancy lines in the sand?!?!

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Double Reversal of the Reversal

On Tuesday, Wednesday and Thursday we saw three separate reversals in the major stock market indices. First, there was a “key” downside reversal after a nice little rally, followed by back to back days of stock selling off early and closing strong. Long time market analyst, Walter Deemer, very aptly replied to one of my tweets that it’s not so much the reversal itself, but the action after those wilder, more emotional days.

People love to cherry pick and and point out reversals at major market tops and bottoms because they worked so perfectly. However, there are many others which see no follow through and the market quickly resumes its trend. My point is that when you see a reversal, it’s time to pay a little closer attention and look for other indicators that support that position.

Stocks are basically chopping sideways with the NASDAQ 100 looking to have the best opportunity for an upside move. The Friday before a long weekend typically has an upward bias so I am watching to see if that fails to materialize and what Tuesday holds. Semis and discretionary are already breaking out and transports are close. Oil looks tired after an epic run but I don’t think the rally is over. After the pullback, energy should see new highs. The energy stocks are a different story. Most bonds are very quietly rallying nicely although junk bonds continue to look like garbage. You already know about my concerns there.

Wishing you a safe and enjoyable long weekend full of family, food and fun.

Thank you to all those who have served our country so courageously, especially those who gave their lives for our freedom.


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“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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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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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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Crosscurrents Abound in May but Fraught with Risk

The month of May begins today. It’s supposed to be spring although you wouldn’t know it in New England on Monday as folks had on hats, gloves and down jackets. The weather is finally looking up in CT as the forecast calls for 70s and 80s this week. I think the bulls are hoping their forecast heats up this week as it’s been cold for stocks of late.

As you know from my blog posts since April 18 I have been much more concerned that the February and April lows could give way to a quick elevator shaft decline towards or below 23,000 on the Dow. It’s a scenario I am watching closely. I would feel a whole lot better for the bulls if we saw some confirmation in the form of a day or two where at least 80% of the volume (shares traded) was in stocks advancing. 90% would be even better. This kind of conviction has been sorely missing since the rally began.

Turning to May which was really the point of this update, like January, there are a number of trends that fire off, both short and intermediate-term. Let’s review them and give proper attribution.

1 – Today is May 1 which has become one of the most seasonally strong days of the year, more so in magnitude than winning percentage. The odds favor the upside 70% of the time. It’s been very rare to see even a .75% down day. (Hat tip Rob Hanna of Quantifiable Edges)

2 – Today is the first day of the month in an ongoing bull market. The previous month closed poorly. 80% of the time, today is an up day with limited downside when the trend doesn’t work.

3 – May 1 begins the “Sell in May and go away” (SIMGA) trend that lasts until November 1. In other words, it’s the weakest 6 months of the year, averaging a gain of 1.5% versus 7% for the other 6 months. However, since the bull market began, only 2011 saw any weakness greater than 1% so that trend has been somewhat muted.

4 – I tweaked SIMGA to look at just those in midterm election years which has historically been a weak year. That worked tremendously well through 2002 with some real doozies on the downside including double digit declines in 2002, 1990 and 1974. Overall, stocks rallied just 1% since 1950.

5 – I further tweaked SIMGA to only examine the first term of a president’s midterm election year which have yielded the weakest of the weak results. 1974 drops off but so do some gains. Overall, it didn’t yield much. Stocks averaged a paltry 0.73% since 1950.

6 – Finally, as I was starting to research what happened when stocks were down through April and SIMGA began, Jason Goepfert from published the results so I will just copy his. I wish I could say “great minds think alike”, but I wouldn’t denigrate him by putting him in my category. When the year was down through April 30, SIMGA was also down by almost 3%.

Does all this even mean anything?

I draw two loose conclusions.

First, in the short-term, today is supposed to be up. If it’s not, regardless of what happens with the Fed tomorrow, I think stocks will continue lower and further open the scenario for a full breaks of the 2018 lows.

Second, there is enough of a seasonal tailwind through Halloween to suggest guarded optimism at best. In other words, when our models are not fully positive, it’s time to play defense and not be complacent. This is such a far cry from what I have written about 80% of the time since the bull market began 9 years ago.

Now is definitely not the time to be cavalier and and regard every decline as a buying opportunity with an easy recovery period. While I still absolutely do not believe the bull market is over and Dow 27,000 is coming, risk has increased dramatically this year and investors should be on guard.

As always, we will take it one day at a time and assess the evidence. If you have any questions or would like to schedule a meeting or call, please contact the office or click here for my calendar.

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Huge Week Ahead. May 1st VERY Bullish

Stocks begin the new week with the bulls on the optimistic side. Yes, the tariff deadline looms, but we also have the Fed on Wednesday, employment report on Friday and earnings scattered throughout the week. Lots going. Lots of ammunition for the bulls, or so they say.

I am not as encouraged for the same reasons I discussed last week and the week before. Lower before higher although I am sure I will feel squeezed if stocks break out to the upside with repairing any of the existing damage. Semis, junk bonds, lack of upside confirmation are all weighing on stocks not to mention the “ominous” 3% yield on the 10 year note which I don’t find to be so dangerous at all.

Today is the end of April and one of the strongest seasonal days of the year is tomorrow. 21 of the last 31 May 1’s have been higher. That’s pretty good. Another opportunity for the bulls to scream. I would become even more concerned if stocks opened higher today and then closed towards the bottom of the range followed by more selling on Tuesday. Let’s see what happens.

Lots going on this week.

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