Opening Gaps the Theme – Financials Leading Banks

As earnings remain the theme over the next few weeks, large gaps on the up and downside at the open can be seen as the more impactful companies report after the close of the previous day. After Wednesday’s close tech giant Netflix delivered a very poor earnings report that looked to weigh very heavily on Thursdays open. However, by morning, those losses were somewhat mitigated and a only a mildly lower open should be seen. After Thursday afternoon’s tech slide, perhaps the bulls will make a little stand.

Price patterns in the Dow, S&P 500 and NASDAQ 100 are now more indicative of a pullback or at least some sideways consolidation than an unabated continuation of the rally. Over the past week or two, we have seen sentiment surveys and option traders show a little too much greed, meaning that they are feeling a little too giddy about the stock market. Typically, after a sizable rally, that can cause some pause or giveback. I certainly do not believe a significant decline is underway nor a bear market.

I continued to be heartened by the recent strength in the semis as well as discretionary. If the banks can get going like the diversified financials have been, we could see another leg higher in stocks during summer. It’s been very interesting to see the banks going sideways while the financials have been so strong. Below, you can see the two groups, banks followed by financials.

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Earnings Season is Here – Internals Fairly Strong

With earnings season beginning in earnest this week, the markets are now focused on two major items, earnings and the Fed. Weaker than expected earnings will give the Fed another excuse to cut rates at the end of July, not that they are really looking for more reasons to cut. With stocks at all-time highs, expectations are now very high for companies to deliver this month. Those that don’t will be severely punished. Sentiment has also become very bullish with the recent move to new highs so any pullback would not be unexpected.

Looking at the major indices, we still have the same issues. While the Dow, S&P 500 and NASDAQ 100 are at new highs, the S&P 400 and Russell 2000 remain well below those levels. The divergent behavior isn’t so much a concern in the right here and now, but if it persists, it can lead to challenges for stocks. On the sector front, semis have stepped up and I do believe they will see all-time highs later this quarter. Discretionary continues to make fresh highs. Transports and banks remain in their ranges and the stock market really needs one to get into gear if we are going to see that run much higher.

Participation in the rally has and is strong. The NYSE A/D Line continues to make new high after new high, behavior not typically seen at the end of bull markets. High yields bonds have pulled back very nicely and constructively although sentiment has certainly soured this month. I don’t think they have seen any kind of peak of significance just yet. Rather, this pullback should end sooner than later and lead to another leg higher in junk bonds.

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Powell on the Hot Seat

Wednesday is yet another one of those media created “all-important” days this month as Fed Chair Jay Powell begins two days of testimony before Congress in what used to be called the Humphrey-Hawkins testimony named after the two Congressmen who created the act. With stocks at or near all-time highs the only precedent for an interest rate like the market is expecting at the end of the month is July 6, 1995 when stocks were also at or near all-time highs.

It’s definitely strange that with rates so close to 0%, the markets are craving more easing. Inflation is the big driver and contrary to what so many pundits predicted over and over again as the Fed was printing $4 trillion, inflation hasn’t been anything close to worrisome in more than 10 years. Europe is weak. So is China. The U.S. is softening, but certainly not weak. Beginning an interest cutting cycle with full employment and almost 200,000 new jobs a month can either be viewed as “insurance”, risky or the Fed seeing something alarming. Given the Fed’s perfect track record of never, ever accurately forecasting recession, we can all but rule out the last one.

I am eagerly awaiting the Q&A session after Powell’s opening statement which will be released well in advance of his arrival on The Hill. No doubt, President Trump’s public criticism will be questioned along with Powell’s view on whether he can be fired or demoted. Don’t expect Powell to engage.

Markets remain the same from my view. Price action, which I deemed as incomplete to the upside, should look much more complete after today, although that has nothing to do with the impetus for a decline. The NYSE A/D Line continues to score new highs and high yield bonds act well. Large declines do not begin with this set up. On the negative side, mid and small caps aren’t close to all-time highs. Sector leadership is not strong as only discretionary is at or close to new highs.

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Don’t Go to The Hamptons – Big Move Coming

With the world seemingly focused on Friday’s employment report, I expected a lot more fireworks than we saw. After a gap lower at the opening and some modest follow through, stocks made it all the way back to even before tailing off to end the day. I have been talking about the rally not looking “complete” yet and that is starting to change. Our models remain defensive and only a break above Dow 27.000 on a daily and weekly close with conviction and strong internals will cause a rethink.

Semis have pulled back very nicely and orderly. They are supposed to rally from here. Failure to do so would be a change of character and warning that something is amiss. Banks remain in a range and can only be seen as neutral here. The death of the consumer has been exaggerated for more than a decade, yet discretionary just powers ahead in a leadership position. Transports are at an inflection point. A close above last week’s high should send them on a run and provide some fuel for the stock market to move higher. A move modestly lower could unleash a summer selling wave of more than 10% which would almost certainly spillover into the rest of the stock market.

Overall, sector leadership from my four key sectors doesn’t appear to be all that powerful right here. This seems like one summer to stay tuned and not hang out in The Hamptons!

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Rally Not Complete Even Though New Highs Waning

Stocks continue the traditional holiday week drift higher. The S&P 500 has made fresh all-time highs and I expect the Dow and NASDAQ 100 to follow suit very shortly. The S&P 400 and Russell 2000 may take some time. While I continue to be a little defensive on stocks over the short-term, some of the indicators within our models that caused that in the first place have strengthened. I imagine the next week or so will be key to see how things like advancing and declining volume behave along with where stocks close each day relative to their range.

One thing I have been commenting about on Twitter is that stocks the rally in stocks still does not seem complete. There are certain price configurations which I look for and I mentioned a some a few weeks ago. The rally has been orderly and well behaved and missing the usual ingredients of ending. We will see what Friday brings with the June employment report and last big piece of data before the FOMC meets at the end of June to decide on cutting interest rates.

One negative that it not factored into our models but making the rounds this week is the number of stocks making new 52 week highs. Below you can see the S&P 500 in the top chart and the number of new highs on a daily basis on the bottom chart.

A few weeks ago, you can see the line spiked to over 300, but now sits below 200 as stocks keep slowly marching higher. That’s your typical non confirmation or divergence. Not all of these are negatives and this is one case where I think it’s much ado about nothing.

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Trump Lays Down As Expected

The G20 meeting in Japan is now behind us. Trump met with Xi and that’s no longer an uncertainty for the markets although you would have to be a fool to believe that something positive wasn’t going to come out of that meeting. That has been the president’s m.o. since he took office. He creates a spike in negativity and tough guy persona wit heels fully dug in to appease his base. Then he emerges as some victor or great person of compromise without really getting anything in return.

Last Friday, I wrote one of my more enjoyable posts in a while. You can view it HERE. I can’t articulate why it was so enjoyable other than to say that there was lots of info to share. In it I offered, “I really would be surprised if Trump doesn’t basically lay down and meet some of Xi’s demands before talks can be restarted.” That’s exactly what happened. Trump gave back exactly what he took back in May and got nothing in return. Xi looks like a hero to his people and I don’t think there is any way that China is making a deal like the one they supposedly got close to in the spring.

Regarding market reaction, I expect it to be positive, but certainly not the home run it would have been before stock rallied so sharply. In other words, stocks were definitely anticipating a positive outcome to some extent. We saw an overall rally with the most tariff sensitive sector, semiconductors, behave very well last week. At the same time, gold stopped going up and I argued on Twitter that a peak may be in. Crude oil jumped nicely as investors believe that global economic growth will pick up with a deal, something I doubt personally. I don’t have a strong opinion on the bond market, but it would be very telling if bonds resisted declining and saw some strength.

Heading into the new week, month and quarter, stocks should jump significantly at the open; no shock there. We want to watch which sectors lead after the first 30 minutes are in the books. We also want to see if stocks can make new intra-day highs after the first hour or so to give the bulls a runway to the close. I have some doubts in that department.

You will  likely hear that because it is a holiday shortened week and a big vacation week that liquidity will be on the light side. Don’t bet on it! Having known about the Trump/Xi meeting at the G20 for weeks, no one who manages money for a living would plan on being away from the markets to begin the week. Whoever spews such nonsense really is a clown.

Finally, with the G20 meeting in the rear view mirror, the next big event is only days away with Friday’s release of the June Nonfarm Payrolls (employment) report. That report should have a heavy influence on the FOMC’s meeting at the end of July.

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HUGE Crosscurrents on Friday

Interesting day on Friday. We have end of week, month, quarter and first half of 2019. The skeptic in me says some portfolio managers could play some games to mark up their positions. I know. I know. You are SHOCKED to hear this. I mean, money wouldn’t cause people to do unscrupulous things, right?

Next, we have the last day for positioning ahead of the G20 meeting in Japan where Presidents Trump and Xi will meet tonight to discuss the tariff tantrum. I really would be surprised if Trump doesn’t basically lay down and meet some of Xi’s demands before talks can be restarted. I think Trump sees a weakening economy that will only be made weaker by all these tariffs. With a reelection campaign kicked off, the president can ill afford even the whiff of a recession between now and election day. I think he has a steep uphill battle in that regard.

The Russell Company is holding it s annual rebalance today when all of the Russell indices will have new and updated constituents with the most popular being the Russell 2000 Index of small cap companies. Over the years, I have noticed some “curious” behavior in the Russell 2000 on rebalance day. Hundreds of billions of dollars are potentially involved and portfolio managers have to decide whether to rebalance all at once, over the course of the day or over a few days.

Friday also ends one of the weakest weeks of the year historically, however, the bears really only had one good day to show for it. Finally, Friday also ends a very short-term trend where small caps outperform large caps. Lots of crosscurrents for sure, but the real fireworks look to be in July with the outcome of the Trump/Xi meeting, June employment report and FOMC meeting at the end of the month.

Stocks certainly are expecting some favorable outcomes, but I wouldn’t say there is a ton of air under the stock market. Our models are on the defensive side for now, but I don’t see more than a single digit pullback if it even comes. I just don’t think it’s a great time to be loaded up with risk, regardless of what happens next week.

*Side note: This update was supposed to go out this morning and I thought it had. Sorry about that!

 

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Mixed Messages – Playing a Little Defense

Earlier last week I wrote about a very binary outcome for stocks. You can reread it here. I thought a bigger move was coming, but the direction wasn’t totally clear. While stocks broke out to the upside across the board, the move was a bit more muted than I anticipated. With so many short-term indicators locked and loaded for higher prices at the time, I will say that the bulls should be a little disappointed. Of course, they could play catch up and render my comments moot.

On the flip side, a few of my stock market models have been in negative positions and continue to flash warning signs. I originally thought that perhaps stocks would breakout to the upside and then reverse lower, turning the break into a fake. That’s still where I am looking. Mid and small caps are really lagging. Only discretionary is leading of my four key sectors. Volume is not constructive and stocks haven’t been closing near the highs on strong up days.

Part of the negativity can be tempered by the strong performance of the junk bond sector along with very broad participation in stocks as viewed by the NYSE A/D Line. In short, I am not excited about the short-term direction for stocks and chose to play a little defense. I think worst case, stocks could pullback mid single digits before another assault on new highs begins.

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Big Move Coming. Binary Outcome.

The stock market begins the week in digestion mode as the Fed meeting looms on Tuesday and Wednesday. Stocks rallied in vertical fashion from June 3 to June 11 and have now paused. The next move should be a good one, whichever direction prices break. The longer the consolidation lasts, the more I would be on the lookout for a fake out, meaning that the first move out of the range sucks people in and then immediately reverses for the real move.

Taking a slightly longer-term view, the rally in stocks off of the bottom can be viewed as “impulsive”, meaning it is the very powerful beginning of something much bigger as you can see below. If this read is correct, the next move will be higher and match the magnitude of the impulse. In other words, stocks would scream higher to new highs.

If the rally off the June bottom is not impulsive and it fails where it says “Can’t Fail Here”, the entire move in June would be retraced and new lows would be seen over the coming month or so. It’s a very binary outcome with a significant move in either direction.

Last week, I wrote about looking for bearish opportunities because a number of our models turned negative. Ignoring what I wrote above, the upside would be roughly 2% or right back to the old highs versus a downside of new lows or at least 6%. That’s 3:1 to the downside.

The outlook should clear up sooner than later and the outcome of the Fed meeting will be one event to help with that. Trump’s supposed meeting with Xi is another.

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Change in Character. Opportunity for the Bears

Earlier in the week, I offered that very short-term, nimble traders could sell the rally as stocks were beginning to look a little tired. I stick by that and still believe that’s a good strategy. Since then, several of our models have started to turn negative which changed my tone to be more defensive and less “risk on”. I think that will likely be the case into Q3 although that’s purely a guess. Of course, I could be wrong and might have to chase stocks higher down the road.

When I do a quick sector review, most of them look very similar with the exception of the defensive ones. They look tired which can be corrected by sideways movement or an orderly pullback. Utilities, REITs and staples look much healthier unless they close below their lows of last week. High yield bonds are holding up really well and that is one sector worth keeping front and center. Without junk bonds rolling over, it will be difficult for the bears to make much noise in stocks.

On the horizon we have the Fed set to meet this month along with the G20 and the anticipated meeting between Trump and Xi. Either could be a positive or negative catalyst although I have a tough time believing that Powell & Co. will cut interest rates this month.

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