Bulls Remain Large and in Charge Despite Pullback

We had a lot of negative news between Friday’s market close and Monday’s open, almost all on the geopolitical front with the vast majority surrounding President Trump. Of course, Deutsche Bank finally agreeing with the markets that they needed to raise capital was icing on the cake. In a weak market, that backdrop would have yielded a 1-2% lower opening on Monday. In a strong market, we’re talking about .25-.50% lower.

Stocks are due and have been due for a pullback or at least a pause to refresh. That looks like what’s happening right now. With so many investors on the outside looking in, any weakness should be mild and followed by further strength until more serious cracks in the pavement develop. I found it interesting that CNBC’s Fast Money midday report was all about the Trump rally ending. I think those pundits will regret those words.

As I watch the major indices and sectors come off their morning lows, I can’t help but notice that high yield bonds are not following suit and lagging. One day or a few days means absolutely nothing, however, should stocks rally with junk bonds falling, I would become more concerned.

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Volatility Genie Trying to Pop Out

After what has been celebrated as this huge, epic rally on Wednesday, the major stock market indices gave back all of their post 9:30am gains and then some on Thursday. I mentioned the other day that volatility compression leads to volatility expansion and vice versa. When the volatility Genie finally gets out of the bottle, we will probably see a sustained increase. I think we’re close to that now. Please remember, volatility does not always mean decline. It means wider price movement in both directions.

Right now, the important takeaways from the week are that small and mid caps look the most vulnerable, relatively speaking. All of the indices remain overbought and stretched but I do not see a large scale decline unfolding. Emerging markets and commodities are under pressure with gold clearly failing at its 200 day moving average. I wrote about oil peaking the other day and the decline may be starting. High yield bonds and the NYSE Advance/Decline Line continue to act well which should buffer the downside. Three out of four key sectors scored fresh highs this with semis very close although banks saw a nasty reversal from new highs on Thursday.

Altogether, this behavior remains very typical of bull markets. Weakness should be bought.

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Energy Stocks Forecasting Crude Oil Decline

Good morning! As I finish this up, I am back at the airport waiting to board an earlier flight than expected back home. I was hoping to sneak away for a few hours and race through 18 holes, but Mother Nature gave us so much rain that the golf course and driving range were closed. So rather than waste a full day, I booked an earlier flight on the always flexible Southwest Airlines. At the same time, my 8 year old called me and said, “Dad, will you please come home right away.” That made the decision a layup and I will surprise them when they get home from school.

The stock market ended the month with lots of yawns. It has been a downright boring week or so. Long time readers know that volatility compression leads to volatility expansion and vice versa. The longer it stays quiet, the bigger the move, perhaps in both directions, when the boredom ends. Very quietly, the defensive sectors have been showing the strongest price action. Utilities, staples and REITs are all at fresh 2017 highs with very little fanfare. If my four key sectors weren’t behaving so well, I would be much more concerned.

One area which has been somewhat of a head scratcher for me is energy. With crude oil trading well and close to new highs, as you can see below, you would think that the energy stocks should be somewhat strong and following suit.

However, that’s just not the case. The next chart below is the exchange traded fund, XLE, or the grand daddy of energy ETFs. After peaking in mid-December, it’s now down roughly 10% with Exxon Mobil at new lows and down almost 15%.

The oil service sub-sector is below and it, too, acts very poorly against the solid crude backdrop. Something just ain’t right.

With the stock market behaving very well and crude oil close to new highs, the energy stocks should be a market leader. They are not even a mid-level performer. Historically, the stocks are smarter than the commodity and lead. Couple that with extreme levels of smart money selling crude oil and you have the makings for a peak in oil and significant decline on the way.

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Ending a Big Week

As I first laid out last week and then again on Monday, this week was expected to be a big one for the bulls. In real time, I wrote about the likelihood for a low that was then confirmed, making me very happy to have called it as it was happening. (In this ¬†business, you get to celebrate so little before the market turns on you!) The only question I had and still have ¬†is, “was that THE bottom or A bottom?”

Not one to hem and haw, I still don’t have strong conviction either way. The higher the major indices go, obviously, the more likely last week was THE bottom. In any case, we have more than enough longs right now to amply participate. I did, however, do a little pruning during the week as our positions melted up a little too far too fast for comfort. At the same time, our global macro strategy bought back the long-term treasury bonds it sold during the wild spike higher last week. For the first time in a long while, our high yield models both turned positive and we now have sizable positions in the junk bond market.

On the sector front, which is very important here, I have seen a number of sectors begin to repair themselves, while some of the downtrodden like, energy and telecom remain dogs. Not so sexy utilities and staples are pushing to new highs along with biotech, but none of those represent strong bull market leadership I want to see.

Gold continues to be very volatile and downright frustrating at times for us. We just took a long position as the miners have fallen too far too fast to be sustainable.

Have a safe and enjoyable weekend! Perfect fall weather in New England and the last weekend of softball games for my daughter, thankfully!

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