Banks Looking for a Bottom Amid General Market Strength

With earnings season in full swing and estimates ramped up by Wall Street, companies will really need to impress for stocks to get a boost. Banks are front and center right now. With the banking index down 10% since the early march peak, I am looking for a bottom in this sector and revisiting of the old highs later this quarter. However, the most important hurdle will be for this group to close above the 93 level, which will effectively negate the most negative scenarios.

With stocks continuing to trade in a small range, there has been strong selling beneath the surface as measured by a technical indicator called the TRIN. This indicator has been relatively high for the passed few weeks. However, the NYSE A/D Line which you can see below and I wrote about the other day, just hit a fresh all-time high this week. Bull markets have never ended with this kind of broad participation and strength. Normally, there is at least three months and as much as 21 months of weakening before the bull market ends.

 

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Sector Canaries Healthy with Some Small Wounds

Turning to the four key sectors I follow, we don’t have as strong a picture as the major indices, but they are still okay. Semis are first and they have been the strongest for some time, almost too strong, but that’s a topic for a different piece. While they have yet to eclipse their Dotcom bubble high from 2000, they continue to make new highs for this bull market.

Banks are next and after a dizzying pace following the election and prospects for reduced financial regulation, they leveled off and are now under pressure from the potential for less rate hikes. Banks should do better in a tightening cycle as rates move farther and farther from zero where their net interest margins improve dramatically. Their early March peak is in line with where it should be, worst case and this is not flashing warning signs just yet.

Consumer Discretionary is next and it looks somewhat similar to the semis with a series of new (and healthy) highs.

Finally, the Dow Transports are below. They peaked with the majority of the stock market in early March, but have since shown the most weakness of the four key sectors. This is the one I would most keep an eye on for future warning signs.

All in all, the sector canaries remain alive but a tiny bit wounded.

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Sector Leadership Immunizes Stock Market from Bear Market

On Friday, I wrote about the Russell 2000 and what a potential breakout could mean for the stock market. At the open today, this index hit a fresh all-time high. Before breaking out the balloons and party streamers, let’s see if it can close at new highs and not give back too much over the coming days. With the Dow closing above 20,000 for five straight days I will have a new target very shortly that looks to be several thousand points higher.

Turning to key sector leadership, it’s continues to be strong and constructive. Semis have paused of late, but continue to trade right up against new highs. While extended, the rally should still have legs.

Banks, which have traded in a tight range since early December, are trying to breakout to the upside right now. Only a failure here and break to the downside would cause me to temper my intermediate-term enthusiasm.

Like the banks, transports have also been in a trading range since early December and are trying to breakout higher  now. That is certainly bullish from an economic standpoint.

Finally, consumer discretionary, which I did not think would quickly reassert itself heading into 2017, has done just that. It now stands at all-time highs.

It’s really hard for the bears to argue that a bear market or even 10%+ correction is close at hand. The major stock market indices are back in gear to the upside as well as the four key sectors. Of course, this strength never, ever precludes a routine, normal and healthy 2-5% pullback. In this case, as I have said for many years, weakness is a buying opportunity.

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Bulls Win Big on Friday But Still Not Ready

Very nice day for the bulls on Friday as the monthly jobs report was really the Goldilocks scenario. Not too strong and not too weak. The U.S. saw decent growth with some mild revisions lower but almost no wage inflation which caused expectations for a March rate hike by the Fed to decline to roughly 20%.

I would not hang my hat on the Fed staying put in March. There are many data points between now and then and I think with the dollar under pressure, they will push to raise.

Except for the Russell 2000, the major stock market indices are now within one good rally from new highs. I still don’t think this is the rally that propels stocks higher on a new leg, but I also won’t be stubborn if the indicators look better. Right now, I see a little more upside and then back to pause mode. Stocks are really priced for perfection and have borrowed a significant amount from the future.

While semis and banks are leading strongly, discretionary and transports are in constructive ranges for now. I fully expect them to join the party, probably later than sooner. Energy may be the most intriguing sector right here as it pulled back to pre-OPEC levels and negativity has skyrocketed. Staples and utilities are also interesting as they are butting up against overhead supply. Should they get a little kick here, those two groups could run higher for a while.

FYI. Until the Dow closes above 20,000 for five straight days, I won’t have any more upside projections.

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Dow Breaking Out & Q4 GDP Miss the Last

After hitting yet another one of my upside targets, 20,000, the Dow has yet to pause. Five straight closes above 20,000 will open up new upside targets before the bull market ends.  As you can see below, the Dow has been consolidating sideways since early December. That’s often referred to as a flat top or box. When prices finally exceed the flat top, they oftentimes see a spurt in the same direction.

Although momentum is on the side of the bulls there are a few short-term headwinds which will present themselves if the rally stalls and closes back in the box sooner than later. Should that occur, I would expect a quick pullback to 19,700.

The NASDAQ 100 has been the leading index since late December, yet it certainly looks a bit tired, the same comment I made earlier in the week. Semiconductors look even more in need of a rest and they typically lead the NASDAQ 100. Keep in mind that all I am saying is that stocks may pause to refresh. The bull market is alive and reasonably healthy. Weakness is a buying opportunity until proven otherwise.

Sector leadership remains strong. Semis, banks, discretionary and transports look powerful although they could use a rest. Industrials and materials are also kicking it into high gear. Healthcare and energy continue to lag, but I think they will have their day in the sun after this quarter.

New highs in high yield bonds and the NYSE A/D Line bode well for the bull market, regardless of the next 5-10% move.

Q4 GDP just printed at 1.9% which was below forecasts. I wouldn’t be surprised if that’s the low print Donald Trump sees for a while and the market just shrugs it off.

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Window for Decline Almost Closed

For the past three weeks, our models have been defensive regarding the stock market after the first week’s post-election surge. I often say that when certain conditions are present, a “window of opportunity” opens for a stock market decline. The longer time passes without a decline, the more likely the window will close. Today, the window is starting to close and I imagine that by two weeks from today, it will be fully closed, modest decline or not.

The  Dow, S&P 500, S&P 400 and Russell 2000 are all in gear to the upside and look strong, although definitely overbought. The NASDAQ 100, on the other hand, has given back all of its post-election hoopla and just doesn’t behave well. While that bellwether index is dominated by Apple, Amazon, Facebook, Microsoft and Google, which have been under strong downside pressure, it would be careless to dismiss this as just a few bad apples (no pun intended). It remains a red flag for now.

Looking at my four key sectors, banks, discretionary and transports are all acting very well and indicating good things for the bull market. Only semiconductors are questionable, however, they really haven’t done anything terribly wrong except see an outsized down day last Thursday. Further supporting excellent leadership is the performance of the materials, industrials and energy. With the defensive staples, utilities and REITs continuing to lag the rally, that adds further credence to the longevity of the bull market. I do think, however, that a short-term trading opportunity may exist as the Fed raises rates next  Wednesday and the most beaten down sectors begin to rally on that news.

High yield bonds are finally starting to kick it into high gear after breaking out to the upside on Tuesday. Even the NYSE Advance/Decline Line is ever so slowly inching back toward an all-time high. Unless something dramatically changes over the coming week, weakness is a must buy into January.

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Stock Market Yawning at Recount

After a small gain on Wednesday, the seasonality bulls got their work done on Friday as the strong trend held to form. Without any weakness leading into that trend, it made it too tough for me to play it. However, I did tweet on Friday that taking a small short position at the close for seasonal weakness on Monday seemed like a better risk/reward play.

Heading into the new week, we have to be on the lookout for the typical post-Thanksgiving hangover early in the week and then the jobs report on Friday which is the final major data point before the Fed raises rates on the 14th. Stocks remain extended and overbought as I mentioned last week, but it doesn’t mean they have to go down right now. They can become even more overbought and extended or they can simply pause and go sideways.

As everyone has been quoting everywhere, the Russell 2000 has been up for 15 straight days, a feat I would never, ever have predicted at any time. At some point, the streak will end. At some point the index will close below the previous day’s low. I am way too chicken to buy that without a meaningful pause or pullback.

The rally continues to look fine and my window for a decline is quickly approaching. Leadership is strong and the internals have improved. High yield bonds are stepping up as well. The stock market doesn’t seem to care about the recount about to take place in several states. Should that Hail Mary gain any steam and possibly reverse the election, that would make the Bush/Gore fight look like a walk in the park compared to a full-fledged constitutional crisis unfolding. Stocks would crater. That scenario is not something I think will happen. It is interesting, however, that Jill Stein has raised more than $5 million that she doesn’t have to give back if it’s unspent or more than needed.

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Seasonals Favor Bulls into Weekend

Today and Friday are well known and widely followed seasonally strong days for stocks. That doesn’t mean we should just blindly buy and hope things work out. Stocks have been almost straight up since the election so you can certainly argue that a lot of fuel has been used up, including the last two days. As I mentioned on Monday, if the stock market was down on Tuesday I would have wanted to be long on Wednesday and Friday. That’s not the case.

Stocks are super overbought, but they can still get even more overbought. The signs of a tired market price-wise aren’t showing up just yet although that doesn’t mean there can’t be a pullback. There’s just no solid edge here. Almost every non-defensive sector except healthcare and biotech is breaking out. Leadership is very strong.

High yield bonds are finally stepping up, but more work needs to be done. The NYSE A/D Line is making new post-election highs, but it’s still not close to the all-time highs it needs.

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IF the window for a decline closes over the coming few weeks, I would expect the aforementioned high yield bonds and NYSE A/D Line to score all-time highs by mid-January. That would give the bull market another strong indications of staying power.

Wishing you a happy, healthy and meaningful Thanksgiving surrounded by those important in your life!

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Bulls Not Done

The bulls came back from the weekend in a good mood as stocks are rallying into lunch on Monday. While banks are taking a little breather, commodity-related sectors are leading with energy, metals & mining and materials all doing well along with some of the beaten down Hillary sectors, utilities, staples and telecom. High yield bonds are finally showing some oomph and emerging market countries are bouncing. The NYSE A/D Line is showing decent participation.

I won’t rehash all the studies out there about Thanksgiving week, but this a seasonally positive week with Wednesday and Friday showing the best returns. If Tuesday is a down day, I would be interested in being long for the last two days of the week, making sure to sell or lighten up ahead of the weekend.

While I am not abandoning my recent concerns about stocks, I am recognizing that the window for a decline will start closing within a few weeks. If one the scenarios I offered last Friday is to play out, we should see weakness begin to manifest itself by the end of next week.

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Three Scenarios to Year-End

On the surface, you would think that the past nine days were nine easy days for the bulls. After all, the Dow was up more than 5%. What could be bad? Beneath the surface, there was much wrong with the post-election rally that began the day before the election. To begin with, the Dow was a leading index, followed by the Russell 2000. The S&P 500 and S&P 400 were nothing special. The NASDAQ 100 was actually down over the two post-election days and is lagging very badly. Reread that last sentence. With the Dow up 5% over two post-election days, the usually leading NASDAQ 100 lost ground over those two days. That is not a healthy market.

Internally, it looks even shakier with the average stock on the New York Stock Exchange closing lower post-election. Now the bulls will argue that it’s because the bond market has been hit so hard and there are a large number of bond-related issues trading on the NYSE. They are correct. The bears, however, will state that these very bond-related issues are the ones which have powered the NYSE Advance/Decline line to new high after new high and their fall from grace is definitely a strong warning sign. The bears are correct as well.

Below, I am going to depict this quandary in two different but similar ways. First, you can see the old tried and true NYSE A/D Line which is just a cumulative total of each day’s number of stocks going up and down. It peaked in late September but so far, has been unable to regain that level and confirm the market’s huge surge.

nyad

Next, you can see the S&P 500 with the 21 day moving average of the number of stocks going up and down on the NYSE. This is a shorter, but also valuable indicator of participation and health in the stock market.

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This indicator peaked back in July and has been almost steadily in decline except for its recent uptick post-election. It, too, is not confirming the strength seen in stocks since the election.

Finally, below is the PIMCO High Yield Fund which is a good proxy for the high yield (junk) bond market. As you know, high yield bonds are perhaps my favorite canary in the coal mine. This sector peaked in October and has been very weak ever since, including post-election.

Something just isn’t right…

phydxOn the sector leadership front,banks, semis and transports, all key sectors, have celebrated the Trump victory in a huge way all soaring to new highs. Discretionary has been the lone key sector hold out, but that group is trying to get its act together as a late comer to the party. This strength in leadership somewhat mitigates the dire picture painted above.

When our research indicates a weak market while stocks are at new highs, I often refer to a “window of opportunity” for a decline. While that window is open, like now, a decline has a higher probability of occurring. Once that window closes, it becomes less likely. I was emailing with one of our adviser clients the other day and Mike asked what were the most likely scenarios I saw unfolding through year-end.

1 – Stocks peak now and decline 4-8% over the next month and rally strongly into year-end.

2 – All of the weakness I described above is absorbed by the market. Stocks pause for a week or so and then roar back to life right into January.

3 – Stocks meander around for another month and then rally modestly into January where they peak and see a 10% correction in Q1.

At this point, I am hesitant to score the scenarios, but the action over the next week or so should allow me to remove at least one scenario. The window of opportunity for a stock market decline has opened and it’s time to play defense. We will see what shakes out. This is not the time to be complacent.

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