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.

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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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The Path to 270 & Stock Market Reaction

Don’t forget to vote!

Thanks to NBC, ABC and FOX in Connecticut for having me on regarding the election. Each segment was very different and offered new information. The first two interviews are below and I will post the FOX one as soon as I have it.

Statistical Model Provides Hints at Presidential Outcome

Financial expert says election could have impact on stock market

It’s been a long two years since the midterm election and I think I can confidently state that the entire country has election fatigue. I would guess that the only ones sad about the election being over are the cable networks and social media platforms as they have seen enormous surges in viewership and usage.

Whether you like it or not, we are going to elect a new president today and the markets will react. If you are on Twitter, I will post comments as states are called and the Asian markets react along with the S&P 500 futures.

Trump’s Path to 270

Looking at my own electoral map, Trump needs to almost run the table in the statistical dead heat states to get close or over 270. Florida is the absolute must, live or die state for Trump while Clinton can lose it and still win handily. Trump then needs North Carolina, Arizona and Ohio to just get him to 259. From there, he probably needs two more blue leaning states, assuming that Michigan and Pennsylvania stay blue as I think they will. The only ones realistically left would be New Hampshire, Colorado and Wisconsin. That’s an almost insurmountable challenge.

If Trump has any chance to become #45, it would likely come as a result of neither candidate achieving 270 electoral votes and the contest would then turn to the House of Representatives where the GOP and Paul Ryan have control. Should this very unlikely scenario unfold, it would be ironic that Donald Trump would need help from the republican he has most battled with and attacked since becoming the candidate to become leader of the free world.

Split Congress Likely

Turning to Congress which matters for the markets, the GOP has a 90% chance of retaining control of the House and thwarting Clinton’s agenda, should she win. The Senate, on the other hand, is essentially a toss up and the nod goes to the democrats, assuming Hillary Clinton is victorious. My count has it 51-49. If that’s the case, it will be extremely interesting to see how President Clinton, a quiet staunch ally of Wall Street, and new Senate Majority leader Schumer, also a Wall Street supporter, deal with Liz Warren and Bernie Sanders regarding the mighty Senate Banking Committee.

How Will Stocks React

Below you can see the possible scenarios and how I believe the stock market will react. They appear as president, Senate and House.

  • Clinton, democrat Senate, republican House (most likely scenario)

Stocks continue to rally for another day or so and then peak this week and gently pullback towards Thanksgiving before attacking 19,000 in December or January.

  • Clinton, republican, republican (2nd most likely)

Almost the exact same scenario as above although the rally will be a bit more muted.

  • Trump, republican, republican (3rd)

Stocks immediately pullback 4-6% to a bottom by Thanksgiving before gaining their footing for a strong rally into the New Year. All-time highs are seen.

  • Clinton, democrat, democrat

The most unlikely outcome causes the biggest problems over the intermediate and long-term as the left agenda goes unchecked with major tax increases on higher income earners, significant increase in regulation and huge expansion of social programs. Stocks become very volatile over the next few weeks before rallying into the New Year. Bear market begins by Q3 2017 and stocks fall by 30-40% by the 2018 midterm elections.

Watch the Reaction Not the News

As I have always said, as an investment manager, I am much more concerned about market reaction to the news than what the actual news is. As such, I will be keenly watching which sectors lead and lag the rest of the week and during any weakness next week. Additionally, healthcare and biotech were decimated over the past few months into last Friday on the prospects of Hillary winning. While they are snapping back sharply this week, it will be interesting to see if their rally has legs or if it’s just a dead rat bounce. Banks have become a vital leader since the BREXIT low in June. Interestingly, it doesn’t seem like this sector is concerned about Liz Warren or Bernie Sanders attacking them or regulating them so quickly.

I will have more this evening on Twitter (@paul_schatz) and tomorrow right here.

Don’t forget to vote!

Regardless of the outcome, the greatest country on earth will still be here tomorrow…

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Time to Buy or Wait

After 9 straight down days and a little help from the FBI, the stock market looks to soar higher at the opening on the increased likelihood of a Clinton victory on Election Day. While I completely understand the “devil you know” argument and continuation of much of the same from the past 8 years, I am somewhat surprised the market is so at ease with the prospect of higher tax rates on job creators and widespread social program spending. However, that could be because the market doesn’t believe that Congress will go to the democrats and without that, Clinton’s campaign theme to significantly raise taxes on higher earners and offer free college tuition is unlikely to happen.

Anyway, as I mentioned after stocks had declined for 8 straight days, another good bull market buying opportunity was close at hand. I’m just not sure that stocks are now launching the rally I see occurring into January. We’ll see in a few days how price responds to the election, where leadership comes from and how high yield bonds behave. The worst case as I see it would be for this rally to peter out in the days after the election, but bottom by Thanksgiving before hitting 19,000 by January or so.

I am sure I will have more to say tomorrow, including a look at my electoral map. My plan is to Tweet as the results come and see how the Asian markets react as well as after hours trading in the S&P 500.

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8 Straight Down Days – Quiet Bear Market?

The S&P 500 is now down 8 straight days. Pundit chatter in the media and on Twitter has been fairly negative. Option traders are bearish. The volatility index is up almost 100% since September. Either a bear market has quietly begun or the market is approaching yet another good dip to buy in an ongoing bull market. I think you know where I stand.

Seasonality studies are abound that the market just entered the best six months. Additionally, it’s also the best three months. With stocks stinking it up, is something amiss? No. In election years, the seasonal tailwind doesn’t usually begin until well into November, sometimes as late as Thanksgiving. It’s been three consecutive down months for stocks, but the pullback I have discussed for months has just amounted to 5%. Better times are ahead sooner than later.

Finally, the stock market’s decline has put it within a few points of touching the average price of the last 200 days, also known as the 200 day moving average. While most people just use it to measure the long-term trend, more than a few investors actually buy and sell based on if price is above or below.

As you can see in the chart, stocks have been above the average since the post-BREXIT rally began in late June. The BREXIT decline was a quick poke below that line which caused more than a few investors to sell right at the lows. That is typical. The first foray below the average sees stop loss orders triggered and then stocks immediately reverse and head higher. Pundits in the media turn this into a “key” test, as if the whole bull market is on the verge of ending because price may close a few pennies below a line.

spy1

The takeaway is to watch if stocks trade below the 200 day moving average, cause a quick bout of selling and then immediately reverse. Long-term, I would be more concerned than I am now if price was below the average and the average was moving down.

Look for my special report on how the stock market is a better predictor of presidential election results than any poll or pundit.

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Key Sectors Holding Up Otherwise Weak Market

Last week, I voiced a little more concern about the stock market as the S&P 400 and Russell 2000 broke to the downside from their trading ranges. So far, they haven’t been able to regain previous levels. Now, we have the S&P 500 and NASDAQ 100 trading at the lower end of their ranges and it looks like stocks have further to go on thew downside before finding more solid footing.

As I have said for months, based on market history, the challenging party needs a lower stock market to have a chance to win. For this election, the number has been 18,000 although the lower the better for Donald Trump. At the same time, I have been using the biotech sector as a bellwether for Clinton’s chances of victory. Interestingly, biotech has been falling sharply since late September which runs counter to the polls and latest email scandal. Of course, fundamentals in the group could be overpowering political models.

On the key sector leadership front, semis, banks and transports have been strong and really holding up the market. Only consumer discretionary hasn’t been cooperating. While utilities have bounced back nicely, staples, REITs and telecom remain laggards which should be good stocks over the intermediate-term.

High yield bonds, which have held up very well are now under modest pressure, another small concern. Although stocks have struggled, treasury bonds are not providing the expected safe haven, even though commodities have also been hit. Adding it all up, you have a bit of a liquidity problem in the markets as it appears investors are building cash positions for now.

The Fed begins a two-day meeting today and it would be a complete shock if they raised rates tomorrow. However, given the political landscape and events of the past few days, nothing can be rules out!

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A Little More Concern Creeps In

At least we had one day where stocks closed firmly! As has been the case for more than a week, but really over the past month, sellers continue to snuff rallies that begin the morning. The bears say that this is a market on the verge of collapsing under its own weight. The bulls counter that with all the selling into rallies, stocks remain just a few percent off their recent highs.

What I am seeing is my pullback theme continue to play out during the beginning of what is usually a very strong time of year seasonally. You also have a tale of different indices with the Dow and S&P 500 mired in a two month range with the NASDAQ 100 just making a new high this week. Somewhat concerning is the action in the S&P 400 and Russell 2000, former leaders, which are now breaking down from their trading ranges.

On the encouraging side, we still have strong leadership from three of the four key sectors. Semis and transports are just off their recent highs while banks and making new highs now. Discretionary looks crummy. High yield bonds scored new highs this week and the NYSE A/D Line is digesting constructively.

While stocks often delay the beginning of the typical Q4 rally during an election year, I wouldn’t be surprised if the S&P 500 has a sharp, but temporary breakdown below 2120 just before election day. That would be a another dip to buy.

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