Stocks into Zone Where Rally May Stall or End

It’s been one heckuva start to 2019. Just listen to the media and pundits tell you how stocks have rocketed  7, 10, even 12% since Christmas. While that is true, it’s a bit misleading as they forget the carnage from Q4. As I wrote about here and here late last year, there was certainly a preponderance of evidence to suggest a bottom and vicious bounce. That has come to fruition and I am glad the market is cooperating with the likely scenario.

Stocks now begin to face the zone I first offered on December 21 as a logical point where the rally may start to stall out or even end as you can see below. The market has done nothing wrong so far, but it has come very far, very fast.

In my 30 years, I have never  been a big believer in “V” type bottoms where stocks fall hard into a low and then rally straight back up, essentially unabated. They are rare and don’t have a super track record. The low after 9-11 was a classic “V” and that ended up failing after a very strong rally as you can see below.

Right now, I am keenly watching for signs that this very powerful rally off the bottom is stalling or ending. My concern remains that the stock market may want to head back down to the Christmas lows and say hello before a more meaningful and sustainable rally takes hold.

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Manic Market

It really is amazing how stocks go from never being able to rally to never being able to decline. After the stock market hammered out the bottom on December 26, the reaction by bulls has been easy to predict. I only wish I did a better job leading up to that low in December. Live and learn which I always do.

At this point, we have seen epic buying since December 26 with all kinds of very positive indicators triggering for the intermediate and long-term. Various breadth thrusts, which I will probably spell out in the next Street$marts, comparable post 20% declines without recession, high yield bonds, sentiment surveys and on and on.

On Christmas, I posted this piece which showed only a handful of comparable environments to the selling we saw in December. While the short-term was not consistent, the intermediate-term certainly was and was a bonanza for the bulls. Although I do believe the internal or momentum low was seen on December 26, I do not believe stocks are off to the races, never to look back. That behavior would be more in line with 2001 and the bear market which I do not believe to be the case today.

Below is an old chart that remains very much in play. You can see how much volatility spiked in December. The very first sign of the selling abating would be when the VIX index fell back into the Q4 trading range below the light blue line. It has already done that.

I think the real all clear sign comes if and when the VIX closes below 16 for a few days which is depicted by the dark blue line.

Stocks have bounced very hard, very fast. I think the easy money has been made in this very first rally off of the bottom. In fact, stocks are getting close to the point where paring back may be the best strategy.

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My Oh My. That was Quick

In my last blog post, Apple had pre-announced less than expected earnings news and stocks were looking sharply lower on Thursday morning. Besides commenting that it was probably a day to just sit back and watch, I also offered that historically, news like this from Apple usually comes near stock market lows.Thursday had an unusually dour feel to it. It seemed like the parade of pundits were all talking about an immediate retest of the Christmas week lows and that investors should be out buying bottled water and canned goods. My Twitter feed was full of Treasury bond bulls taking victory laps and calls for a much worse bear trend.

VOILA! Thursday ended up being a sweet bear trap.

There were three very good pieces of good news on Friday. First, overnight, the People’s Bank of China lowered reserve requirements which effectively puts more into the economy, a sort of stimulus. That got pre-market trading to indicate a much higher opening for the U.S. Then the December employment report was yet another blockbuster! 312,000 new jobs created. More people back in the workforce. Wages growth hit 3% again. These are just not recessionary numbers, at least not yet. Finally, and perhaps most importantly, Powell, Yellen and Bernanke all appeared on a panel at the Atlanta Economics Club where Powell reversed course very sharply from just a few weeks ago. It really is amazing what a 20% decline in stocks will do a hawkish Fed chair.

Boy did stocks respond, for the second time in two weeks.

While we didn’t have another 1000 point gain, stocks did soar more than 3% and again we saw 95% of the volume occur in stocks that were up. That is usually a very goo sign for the intermediate-term. With sentiment so negatively extreme, there is a good backdrop for the bulls over the next 3 to 6 months, even if that means a revisit to the Christmas week lows this quarter. I thought it was a very good sign that high yield (junk) bonds saw a lot of love and interest. That hasn’t happened in a long while.

The past two weeks have been good steps, but there will be other tests, likely at higher prices for the bulls to pass. I want to see the VIX close under 16 and the number of stocks in uptrends climb back above 60%.

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Santa Claus Came a Callin’

The media spent the period from just after Thanksgiving to mid-December parading out pundits to talk about the Santa Claus Rally (SCR). Most of those pundits said the SCR was failing and it meant trouble for the stock market in 2019. I wrote several times that the traditional SCR, pioneered by Yale Hirsch of the Stock trader’s Almanac, was simply the last five trading days of the year and the first two days of the new year. An up SCR meant good things to come for the New Year while a down one meant stock market downside. There’s nothing more to it. There’s no discretionary element or opinions needed.

Research showed that if the last five trading days of the year and first two trading days of the New Year (Santa Claus rally) did not show a positive return, a bear market or significant correction was likely during the coming year. While that was certainly the case years ago, recent history since 2001 shows a significantly muted trend and I wonder if this trend has been fully diluted because of computerized trading, the proliferation of ETFs or even decimalization.

Bears love to point out that Santa did not call in 1999 nor 2007 when two devastating bear markets were about to unfold. However, Santa also did not call in 1990, 1992, 1993 and 2004, yet no bear market or major correction ensued the following year. Santa also did not come in 2014, but I am sure proponents of this trend would point to the 15% summer decline as evidence that it “worked”. In 2015, Santa was a no show and stocks were in in the midst of a 15% correction which bottomed on January 20, 2016. How would they score that?

Conversely, Santa called in 2017 (+1.04%) but look what happened in 2018, a significant correction and down year! In 2010, Santa showed up but stocks saw a 20% decline in 2011. Santa came in 2000 and 2001, however 2001 and 2002 were awful bear market years. 1997 saw a big Santa Claus rally, yet 1998 had a 20% correction. The same can be said about 1989 and 1986.

I bring this topic up each and every year, not because I am a huge supporter or believer in the SCR, but because the masses are mostly wrong about it. It’s not some nebulous, loose thing. And from my seat, depending on the year you start, there is roughly a 70%+ chance of an up year regardless. The SCR is a cute seasonal trend, but far from anything worthwhile in managing money.

For what it’s worth, the SCR just ended at Thursday’s close with the following results.

Dow Industrials +1.07%

S&P 500 +1.28%

S&P 400 +1.30%

Russell 2000 +3.02

NASDAQ 100 +1.65%

 

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Bulls Fighting to Begin the Year But Apple, Apple, Apple

After opening down 400 points on the first trading day of 2019, the  bulls fought back really hard to erase 100% of that loss by the close and eke out a small gain. That was very impressive. Leadership came from the most beaten down sectors from 2018, energy and financials. That’s not surprising. So many investors sold those names during Q4 for tax loss reasons as well as window dressing to make their portfolio holdings look better than they actually were. January 2nd was definitely a risk on day as the defensive sectors were in the red all day.

That kind of across the board reversal would ordinarily carry over for at least a day or three. However, Apple pre-announced sales that were much lower than expected after hours yesterday and it looks like a repeat on Wednesday’s open. I would be very, very surprised if stocks were able to shrug off this bad news and reverse for a second straight day although history does suggest that action like this in Apple that spills over into the rest of the market usually comes near some type of low.

In short, I think Thursday is a watch and wait kind of day. Let’s see if market internals are stronger than price action. Let’s see how stocks trade after lunch and into the close.

It’s also the final day for the Santa Claus Rally…

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Big Gains to Close the Year But the Bulls Remain on Their Heels

Welcome to 2019!

I hope you had an enjoyable and safe New Year’s. We had an absolutely wild and crazy one. It was one for the ages! I think my wife and I were fast asleep by 11pm although I am told that the kids were up until 1am. It’s good to be young. We were in Vermont and had some folks over for a very low key evening as yet another non snow producing winter storm came through as sleet, ice, freezing rain and then rain. It was the third such storm in 11 days. Frankly, Vermont has had enough rain lately to last a year. It’s time for some snow!

Before I dive in to the update, I am scheduled to join Fox Business’ Making Money at 2:50 pm on Wednesday with my old friend Charles Payne where it will be all about the stock market.

Stocks finished the year in very strong fashion with the major indices up between 6% and 7 % since the Christmas Eve low. Most people are surprised at the magnitude since few feel really good after December’s drubbing. The last 5 trading days produced outsized returns for the bulls, however nothing that hasn’t been seen a number of times since 1990. 2008, 2000, 1997 and 1994 all saw similar outcomes to close the year. Anytime you invoke 2008 or 2000, investors begin to sweat and shake although 1994 and 1997 does not bring back fear and panic attacks.

Furthermore, while stocks did add to those gains to begin 2009, they did end up give back all of those gains and another 15% by the time a generational bottom was hammered in by early March. 2001 saw the year begin on a sour note and that continued right through to the low point of the year on September 21. 1998 started on the weak side, but the bulls quickly recovered from New Year’s Eve and saw soaring prices into July. 1995 began without much fanfare and that turned out to be the single greatest year in modern investing history.

So what does all this tell us for 2019? Not much. In this specific case, history isn’t much of a guide. One area where history is a good guide concerns which market segment is supposed to lead over the first 5 trading days of the year. For 2019, that’s the S&P 400 Midcap Index.

Circling back to how stocks closed 2018, in very unusual fashion, the major indices fell roughly .75% 10 minutes before the close and then rallied 1% into the close. Such wild gyrations usually lead to a giveback of the last move early the next day which would be first thing Wednesday morning.

I will have more on where I think stocks head in January as well as Q1 soon. With the first day of the month, quarter and year here, this is always the single busiest time of the year. In short, the odds favor January being a down month and the first quarter a little sloppy and messy as the bottoming process continues.

Finally, if you’re keeping score at home, the Santa Claus Rally has two days left.

Once again, I want to wish you and your family all the best for a happy, healthy, safe, peaceful and prosperous 2019!

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Bulls and Santa Claus Making a Stand. One Indicator for the All Clear

December has already set all kinds of precedents going back to the 1800s, including depth of decline, speed of decline, length of decline and intensity of decline. Remember, stocks just don’t decline all that often in December, ESPECIALLY during a mid-term election year where Q4 and December has almost always been like shooting fish in a barrel. I had to go all the way back to 1931 to find anything remotely similar, but let’s face it, price analogs that old don’t have a lot of relevance.

After seeing the single worst pre-Christmas trading day and pre-Christmas trading week, the stock market put in a rather dramatic low during the morning of the 26th when supposedly “no one” was working. It reminded me somewhat of November 25th, 2011 when stocks were selling off hard after a what turned out to be a major bottom a month earlier. November 25th, you see, was one of the holiday-shortened half trading days when “no one” was working.

Anyway, the day after Christmas, Santa Claus certainly came a calling as stocks rocketed roughly 4% with the Dow Industrials soaring more than 1000 points. While that gave investors lots of cheer it only retraced two days of the selling wave since the December 3rd peak.

As I have written about repeatedly, the post-December 3rd selling wave set all kinds of precedents and saw countless indicators, relationships and models all fail in glorious fashion. The absolute worst case for stocks was that they were “supposed” to bottom on December 10th.

Trading behavior on December 26th set a number of positive precedents of its own along with triggering a wide array of indicators, relationships and models which say that the internal or momentum low has been set and the market would next begin the bottoming process again.

Let’s talk about some of these indicators.

Of the 505 stocks in the S&P 500 (I know. Shouldn’t it be just 500?), 504 went up on the 26th. Only Newmont Mining, a gold stock, declined. That kind of dramatic and overwhelming action is among the most lopsided in history and appears in and around significant stock market bottoms.

More than 90% of the volume on the 26th was in stocks that advanced. Depending on your data source, that number was likely around 95%. Powerful action like that is also seen during the bottoming process as stocks either initially surge from a low and blast off from a secondary bottom.

No matter which put/call option ratio I look at, they all point to excessive pessimism at the low on the 24th. You can see the CBOE one below. The masses loading up for further weakness.

As with the various put/call ratios, most sentiment surveys showed an excessive amount of negativity among investors into Christmas week. Below you can see the American Association of Individual Investors. More than 50% were negative which is a number often seen in and around significant price lows.

Turning to the percentage of stocks in uptrends or bull markets, I elongated the chart below so you could see the entire bull market. You will notice that at every low of the bull market, even during the “mini bear markets”, less than 15% of stocks on the New York Stock Exchange were in uptrends. That same condition was met last week. It is worth noting that during the financial crisis, that number was around 5%.

The Investment Company Institute reported that investors pulled more than $46 billion from mutual funds through the 19th. I expect that number to jump even more when data are reported this week. Although you have to take money flows in December with a small grain of salt, $46 billion is absolutely massive and was only seen during the financial crisis.

This tells us what every other item I mentioned already has; investors are in panic mode. Behavior like this doesn’t guarantee the bottom, but it does say that the vast majority of the damage has already been done. It says nothing about volatility or the complexity of the bottom forming or when the recovery will be complete.

In today’s case, a “V” type bottom where stocks just rally from here unabated to their ultimate peak is the less likely and less preferred scenario. That price action would have be more indicative of an ongoing bear market. Instead, the more preferred and likely scenario would be for a complex low that forms during Q1 and leads to sharply higher prices in Q2 and Q3.

Finally, someone always asks if there is any indicator they should watch to signal an “all clear”. Below is the Volatility Index, more popularly known as the VIX. The VIX always spikes higher into stock market bottoms. “Higher” is relative which is why I included the whole year. If you just looked at Q4, the spike looks really high. Showing the February spike as volatility products imploded gives a whole different perspective to a spike.

All the way on the far right of the chart you can see two arrows drawn in. The first and little one shows you where the VIX potentially declines back into its previous trading range. That would be the first confirmation sign of a low and momentum peak. The second arrow points to the VIX closing below 16 which would signal a return to normalcy. Keep an eye on both levels.

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Extreme Selling Leads to Rare & Immediate Reaction

After already discussing the legendary selling wave stocks experienced this month through December 24th, one of the sub models within our big stock market model triggered a scenario based on historic levels of overdone selling that has only been seen a handful of times since 1980. Each and every time, stocks saw significant gains almost immediately, even when in the context of a bear market.

You can see all of these on the charts below with the arrows pointing to the triggers, including the most recent one at the close on December 24th. If this sub model works anything like past instances, stocks should be rallying before the week is over. If stocks continue to crater, it will be yet another case in what is becoming a very long line of failed studies and indicators this month.

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The REAL Santa Claus Rally

All month I have heard the pundits say that the Santa Claus Rally has failed or that Santa failed to call so bears will come to Broad and Wall, popularized by Yale Hirsch of Stocks Trader’s Almanac fame. What incenses me is that those people just blurted and babbled nonsense. The Santa Claus Rally (SCR) doesn’t begin until the last five days of the year and continues for the first two days of the next year. In other words, it literally just began at the close on the 21st with the Dow Industrials at 22,445 and the S&P 500 at 2417.

As I look at the prospects for a SCR, there are two pieces of information I look at. First, is the stock market up or down for Q4 to date? And second, is the stock market up or down year-to-date? In today’s case, both answers are down which is somewhat rare.

Since 1950, there have only been 7 cases where both periods have been down heading into the SCR period. Not surprising, most were during bear markets. In 6 cases, the SCR was up and 5 of the 6 saw significant gains. Only 1977 saw a very small SCR loss of -0.30%. 1994 saw a minute gain of +0.22%. The average SCR gain was a healthy +3.89% with the median clocking +4.64%.

If the past has any validity here which I believe it does, the SCR should perform in line. That means a fairly significant rally of 2-5%.

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From Lower Levels, a Bottom Coming

After last week, I am running out of adjectives to describe the stock market decline since December 3. Relentless seemed like the best word a week ago, but now it’s almost an understatement. Although I thought I had written my last long update before the Fed meeting, I had also thought that stocks would at least see a temporary low. I was wrong on both counts and am working on another update now.

Almost every day last week looked similar. Carnage across the board with almost no place to hide. I have said this before, but I think it still has merit to mention again. The decline has the “feel” (which I often say is not real) of needing a “clean up” day to force more selling and cleanse the market of any remaining sellers. Given the size of the decline so far, that could end up being a 1000+ point down day. Talk about unsettling investors over the holidays.

I would be really surprised if stocks just jump up at the open and rally sharply into the New Year. That would end up being a much worse scenario and need more downside before the initial low was in  place. This would be the same sentiment I shared for weeks after the October 11 low when I said that if stocks just rallied right back to new highs (they didn’t), I thought the bull market would end in Q1 2019. Significant, major or meaningful bottoms have very similar characteristics year in and year out, decade in and decade out.

A bottom is coming, but I believe it has to come from lower levels.

For those celebrating Christmas, I wish you and your families the happiest one of all, surrounded by loved ones. Some good food and cheer won’t hurt either!

 

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