As Expected, Pullback Continues

All month I have been writing about a short-term pullback for stocks. Nothing huge. Just your garden variety 3-5% bout of weakness which could overshoot. This coming from someone who has been bullish all year on stocks. I won’t reanalyze what I have already written several times, but here are a few reasons. The Dow Industrials were off on their own island of strength while the mid and small caps were in decline. Dow Transports were even weaker. Sentiment surveys and option data had become too greedy, too complacent and too positive. The list of stocks making new 52 week lows expanded and then surpassed those making 52 week highs, all while the major indices were so close to all-time highs. Key sector leadership fell off.

The stock market was just looking for a catalyst or an excuse to pull back.

First it was North Korea and then it was Charlottesville and now it’s Barcelona and Gary Cohn. The common thread in each case is President Trump. Since the post-election rally, dubbed the “Trump Rally”, “Trump Jump” and “Trump Bump”, I have remained firm that while the president always gets credit and blame, the rally was really based on the GOP’s election sweep and perceived ability to govern and pass legislation as they saw fit. That agenda is now being questioned and you will likely start hearing the media and pundits refer to the pullback as the “Trump Slump” or “Trump Dump”.

You don’t read this blog to hear my social views so I am not going to a rant about what’s going on in the country today. Suffice it to say that for as long as I can remember back to my childhood, I have always fought and stood against racism, bigotry, intolerance, discrimination, hatred and evil. They have no place in this country or on earth. There are no exceptions to this. At the same time, free speech is one of those inalienable rights which we often take for granted. However, it’s not really 100% free speech as you can’t scream “fire” in a crowded theater. There are limitations. Those a lot smarter than me will likely be struggling with this over the coming years if the 9-year escalation of racism, bigotry, hatred, white supremacy & neo-nazism continues.

That was more than I wanted to write, but it wasn’t quite a rant. Anyway, back to the markets and what’s at hand. The pullback is continuing as planned with Thursday being the first across the board rout where basically everything went down. For those looking for a silver lining, the defensive groups like staples, utilities and REITs were hit along with the others. That typically confirms the decline and indicates more downside before a low, but it’s getting there. It’s a necessary piece towards an eventual market bottom.

On the positive side, while high yield bonds have declined, their weakness has been small although I sense more downside is coming. The semis which I wrote negatively about here have been the quiet winners during the pullback and are the lone holdout from making new lows. It will be very interesting and telling to see if they can hold up.

With all of the major indices in gear to the downside, it’s unlikely that the current action is just a re-test of the North Korea decline from last year. Momentum is making a fresh low now so we are likely to see at least a low, a rally and a new low before the whole decline wraps up. I had written about a rocky period into mid-September and I am not ready to change that opinion just yet. Let’s see what shakes here. Don’t forget that the Fed has their annual retreat next week in Jackson Hole WY. With Janet Yellen and Mario Draghi (ECB) both in attendance, we should expect to hear more about their respective balance sheets.

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Stocks to Bounce But Pullback Not Over

In part II of the piece I started last Friday, I turn to the market evidence supporting the 3-5% pullback I have been discussing all month. While tensions with North Korea have quieted down over the weekend and global stocks are sharply higher, I do not believe the pullback is over. Now, if the five major indices scream right back to new highs and sector leadership is strong, I will clearly be wrong in this call, but I am willing to give it some time. Let’s see if the bulls can first retrace what they lost last Thursday.

One of the many reasons I started looking for a pullback can be seen in the charts below. Just take a cursory glance and you will see that the Dow Industrials are leading the parade with the S&P 500 just behind. The S&P 400 and Russell 2000 are lagging significantly. The NASDAQ 100 is just a tad better.

Leadership by the Dow does not equate to healthy and strong leadership. It’s exact opposite. Investors are looking to hide in the “safer” and more liquid areas. If this was one of my regular Canaries in the Coal Mine update, I would offer that none have died or are close to dying, but a few are coughing.

Stock market sentiment began to get a little too happy, complacent, greedy or whatever other adjective you want to use. We saw it in the surveys, the options data as well as the Rydex fund flows. While sentiment ebbs and flows at a good pace, weakness is likely needed to restore at least a small wall of worry.

The semiconductors are one of my favorite sector canaries and concern over the past few weeks has been that with the NASDAQ 100, software and internet sectors all scoring fresh new highs, the semis have been unable to. If they started to rollover, they would likely bring down the rest of the tech sector with them.

The Dow Transports are another sector which had been under pressure long before North Korea became a recent issue. You can see below its decline was more than just a few day event and warrants attention.

Until earlier this week, I was holding out hope for the bulls by the continued strength in the high yield bond sector, my favorite canary in the coal mine. However, the past three days have seen relentless selling in this sector. Something has changed in the character of the market.

I could add to my list of short-term concerns including the infamous Hinderburg warning which really just says the market is very split with an equal number of stocks doing well as poorly. The number of stocks making new highs and new lows has shifted significantly to the negative over the past week adding credence to the Hinderburg.

HOWEVER (isn’t there always), the New York Stock Exchange Advance/Decline Line, which measures market participation just hit an all-time high earlier this month. Historically, that pretty much insulates stocks from a serious decline or bear market as it shows good health and lots of liquidity.

Finally, the much talked about VIX which is a broken measure of anticipated volatility spiked by almost 50% this week and almost 100% from its recent low. That has been a strong indication of future gains several months out.

In short, the next few weeks to month or so could be rocky, but not cataclysmic. Besides North Korea, we have the single biggest geopolitical since 9/11 on September 24th with the German election. Stocks are wounded and need some time to heal, but more new highs are in store later this year and into 2018. If you are nimble enough, selling short-term strength is the right strategy until proven otherwise.

As hard as it may be, investors would be best served by not being glued to the news channels 24/7. Focus on the long-term. The economy’s growth is accelerating. More jobs are being created. Record earnings. Heed my theme of 2017. Reality over rhetoric!

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Short-Term Pullback in Motion

Over the past week or so, I have gone from a trading range view with perhaps a slightly upward bias to a mild pullback of 3-5%. That’s where I stand today. Stocks sold off very hard on a relative basis from noon to the close on Tuesday as the saber rattling between the U.S. and North Korea continued. President Trump kicked it up a notch.

Regardless of the news, the markets were already in a position to pullback as I outlined in the past few posts. This should not be a huge deal, but it’s one where I am going to be a bit more vigilant than at any time this year. Perhaps a little pruning, hedging or even some sales as multi-year highs were rejected in the Dow and S&P with the mids and smalls doing even worse. Even high yield bonds had their worst day since early July. At the same time, defensive sectors like utilities and consumer staples behaved very well.

Again, I am not looking for anything substantial, especially since we are not seeing the internals collapse or across the board selling. This just looks like your plain vanilla bull market pullback.

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Economy Good. Markets Less So.

On Friday, the Department of Labor reported that the economy created 209,000 new jobs, which was 26,000 better than expected. The unemployment rate fell to 4.3%, the lowest level in 16 years. This is just another statistic that supports my thesis that economy is in better shape than the masses realize. You wouldn’t conclude this if you spent your day watching TV. Reality over rhetoric. I don’t care if this is coincidental, Trump’s doing or lack of doing or Congress. It’s irrelevant who deserves the credit.

And if you don’t like pouring over economic reports, just look at the stock market for a report on the economy. While imperfect, it does a great job at leading the economy. The problem is that the market sometimes gives warnings which don’t lead to recession. The old joke is that the stock market has predicted 7 of the last 4 recessions. However, it doesn’t miss recessions.

Turning to the markets, while the Dow continues to make new high after new high and the S&P 500 is close to a fresh high, the mid and small caps are several percent below their highs with the NASDAQ 100 somewhere in between. Sentiment is a bit on the excited side, especially with the media and pundits celebrating Dow 22,000. Semis and transports are lagging. However, high yield bonds and the NYSE A/D Line are just below all-time highs and behaving very well.

Again, I am not looking for anything more than a 3-5% bout of weakness during a seasonally weak time of year although with stocks so close to their highs, the negative seasonality should be somewhat muted. I don’t think this is the time commit fresh money.

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Q2 GDP Frustrates Bears. Bezos Still Rich?

The government released its first look at Q2 economic output and the economy grew by 2.6% at first glance. While I would have been happier with more, it’s the second straight quarter that seems to be falling in line with my forecast. Earlier this year, I offered that Q1 GDP would come weak and below expectations with Q2 much stronger. That’s certainly the case today. I am also looking at Q3 to be stronger than Q2 with a shot at eclipsing the 3% mark. That won’t be easy. My forecasts were based on widespread deregulation and tax reform. While the former has been happening quickly but quietly, the latter isn’t even being discussed yet, a huge mistake in my opinion. I still believe tax reform is more than a 90% certainty, but it likely won’t have a positive impact on our economy until 2018.

All week long, the media fell over themselves, gushing that Amazon CEO, Jeff Bezos, was now the richest man on earth. As is often the case when something becomes so widely accepted or loved, the opposite happens. Amazon quickly gave back all of this week’s gains on a less than stellar earnings report. Classic buy the rumor, sell the news.

The tech sector, mid caps and small caps all saw reversals to the downside this week as all of the major stock market indices poked to new highs at the top of the trading range I have been discussing for a while. It’s likely that a pullback has begun and some mild weakness will ensue.

The two things that concern me most are below. First, I mentioned that semis need to make all-time highs as their software and internet cousins have. Rolling over first will definitely bother me.

Second, the Dow Transports are very quietly down 5% from the July peak. This bellwether index has definitely marched to its own tune for several years,  but I would still rather see it behaving a whole lot better. Thankfully, junk bonds continue to act well and confirm the new highs.

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Trading Range Continues But Lots Beneath the Surface

Stocks fared fairly well last week in the face of overbought conditions and a few tiny cracks in the pavement. As I continue to offer, I believe the bull market is alive and reasonably healthy, especially for one 9 years old. However, my shorter-term view is that stocks are in a trading range with perhaps a slightly upward bias for the time being. The stock market just doesn’t seem like it wants to launch a fresh leg towards my next target of Dow 23,000. On the flip side, while it’s long overdue for some kind of pullback, I do not believe it will be anything but shallow unless there is some kind of geopolitical event.

The four major sectors are behaving very differently. While semis have bounced back smartly from the June swoon, they are lagging tech and the NASDAQ 100 and really need to score a fresh high sooner than later. Discretionary is behaving much like semis and need a new high close as well. The transports have pulled back more than 2% and look very interesting from a bullish perspective. Only a close below last week’s low will change my opinion. Banks continue their 2017 trading range and do not appear to be ready for an upside thrust just yet. Finally, high yield bonds are quietly scoring new highs which has bullish intermediate-term implications.

 

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Stocks Tired. Energy and Transports of Interest

It’s been nothing short of amazing how many people keep calling for a bear market, correction or even single digit pullback. On top of that, we are now hearing calls that the VIX (volatility indicator) is either broken or no longer works. Lots of sour grapes out there! The bottom line is that the ingredients for a major decline are not present and have not been present for a long while. That’s going to change, but it will take some time to do so.

With all that said, stocks do look a little tired, but that doesn’t mean they have to go down. They could also move sideways to repair themselves. If we do get any weakness, it should be yet another in a long line of pullbacks to buy.

On the sector side, all is not well, but it’s good enough to keep this aging bull market going. I discussed energy a few weeks ago as being in a position to form a low and it has rallied nicely. However, it’s now at the point where the bears should make their stand if they are going to. If not, this will be a good sign that a more significant low may be forming. At the same time, transports have quietly pulled back 2%+ this week. The bull should attempt a stand sooner than later and this index could give us a clue as to the market’s next move.

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Bears Move to VIX as Indices All See New Highs

The bears tried to put up a little fight on Tuesday, but that only lasted a few hours and it wasn’t much of a battle. On Wednesday, the bulls came right back with the big guns and a headline close that saw all of the major stock market indices see fresh all-time highs along with high yield bonds. While I had been looking for the Dow, S&P 500, S&P 400 and Russell 2000 to see these levels, I did not expect the NASDAQ 100 to do so this quickly.

The chart below shows the path I was looking for with one more small decline in the index just below the May bottom. As the index began to rally and lead, I offered that I would like to see the other indices lead the market lower on the next pullback and then see the NASDAQ 100 soar again. There was no next pullback which is still okay.

At this point with all of the major stock market indices seeing blue skies, the bears are focused on the volatility index or VIX which is showing overwhelming complacency, or at least that’s their take. The VIX is a funny animal and its behavior has certainly morphed over the years as tradeable products have been introduced. I don’t have a strong opinion right now on the continued value of the VIX, other than to say that we should be able to discern something a few months from now.

In short, I remain in the trading range camp with a slightly upward tilt and do not think the across the board new highs are the beginning of the next leg to 23,000. I think we need some backing and filling over time or a pullback first. This is definitely not how bear markets begin!

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Bulls Don’t Want to Quit, But…

The bulls had another strong day on Friday with now the S&P 400 and Russell 2000 on the verge of fresh all-time highs. Semis continue to bounce back. Transports remain strong and discretionary and banks are behaving constructively. Materials and industrials are quietly in high gear and long depressed energy is ticking higher. High yield is also picking up again and you know my feelings on that along with the broad participation seen on the NYSE. Just keep in mind that this is not a young bull market so it’s behavior won’t be as rock solid as one in its early stages.

This week we have option expiration, but I do not believe it is going to play a big role in market direction. Earnings season picks up and that should make for some fun. Although volume has lagged for a long while, given that it’s summer, I would expect it to get even lighter barring an external market event.

Although I continue to paint what seems to be a rosy picture, my intermediate-term forecast remains the same. I believe stocks are in a trading range until proven otherwise with perhaps a slight upward tilt.

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Another Good Day for the Bulls

After a number of short-term victories for the bulls over the past week, the Dow Industrials and Dow Transports scored new all-time highs together, triggering a Dow Theory confirmation or buy signal on Wednesday. While the Dow Industrials were the lone major stock market index to see fresh highs so far, I expect the S&P 500 to follow suit shortly. The S&P 400 and Russell 2000 should not be far behind which would add even more credence to my forecast of limited downside. However, I still do not believe that stocks are ready just yet to blast off on another leg higher. As the NASDAQ 100 repairs itself, I think the stock market remains in a trading range which will eventually be fully resolved to the upside.

Participation in the rally remains very, very broad and strong no matter what you hear differently from the pundits. These are the same pundits who were negative after BREXIT and the election last year and continue to scream about a major decline or bear market starting. The chart below says it all. The NYSE A/D Line is once again at all-time highs. While it’s not 100% perfect, this indicator rarely looks so strong as a bull market is ending. When I say “rarely”, I believe it has only failed once in the modern era. In any case, with high yield bonds stepping up again and the other evidence I continue to point out, buying weakness is the correct strategy until proven otherwise.

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