Pullback Remains in Place. Junk May Hold Key.

The short-term pullback I have seemingly written about for weeks and weeks remains in place although I am certainly not taking credit for calling it in a timely fashion. The Dow, S&P 500 and NASDAQ 100 have all pulled back constructively while the S&P 400 and Russell 2000 are uglier. The three stronger indices are just about to kiss their 21 day moving averages, while their weak cousins knifed right through the 21 as well as their 50 day moving averages. While the 3-5% pullback I keep talking about is here, the average stock is now off roughly 10% which is masked by the strength in the major indices.

Turning to the four key sectors, banks, semis and discretionary are holding up very well and only a solid two day rally or so from new highs. Transports, however, are under more pressure although certainly not bull marketing ending behavior.

Both high yield bonds and the NYSE A/D Line saw all-time highs in early March, but have since pulled back more significantly which is something I discussed recently. The junk bond decline definitely has my attention and should be watched very closely. The sector began to lag last week and is now down sharply this week.

The A/D Line, while weak, is still behaving constructively.

Stocks are finally pulling back and giving all those folks who sold last February, post-BREXIT and at the election a time to buy. I doubt they will until the train leaves the station again. The bull market isn’t over.

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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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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.

nyad

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.

spx21ad

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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Bulls Want to Fight

After a clear loss to the bears last week, the bulls closed Friday well off the worst levels of the day and closer to the highs. That price behavior usually leads to some follow through buying the next day. Looking at the five major stock market indices, they look very different, which is not normal. The Dow and the Russell 2000 oddly look the most similar with the S&P 500 and S&P 400 together. The NASDAQ 100 has the most bullish configuration, which makes sense as the likes of Amazon, Facebook, Netflix and Google have been leading that charge.

The stock market is supposed to bounce right here and now, but it is highly unlikely that the bulls have enough energy to go very far. While I do not believe the ultimate bull market peak has been seen, I also don’t think that stocks have hit their intermediate-term low either.

Sector leadership is fragile and junk bonds continue to really struggle. Both concern me, but the junk situation even more so. These bonds are acutely sensitive to ripples in the liquidity stream and very good leading indicators for the economy. We will continue to watch them closely.

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Short-Term Tea Leaves Say Bulls About to Step Up

The stock market remains on the defensive as I have written about for some time, not that this is a repeat of 2008 or even 2011. It’s not even your garden variety 10%+ correction. Stocks remain in the range they have been in for most of 2015. From a bullish perspective, it’s a good intermediate-term sign that after the huge run up we have seen, the bears can’t even muster a 10% correction. From the bearish perspective, stocks have stalled and there has been internal damage done. As you know, I strongly side with the former.

Too much bullish sentiment has been one of my chief concerns over the past few months and while that has not totally abated, it’s not as bad as it once was. Behavior from the Dow Jones Transportation index has been poor since late last year and for the most part, that continues today. I do believe that when the market launches the next significant rally, the transports will be in a leadership position.

Bears keep pointing to the declining number of stocks participating in the rallies as a serious warning sign. If that number was much worse, I would be much more concerned. Remember, the New York Stock Exchange advance/decline line, saw all-time highs in April, a good sign, although it fell off when the Dow hit its most recent peak in May.

Sector leadership has been very bullish. No one can argue that point. If the economy was on the verge of recession, we would typically see defensive sectors like consumer staples, utilities and telecom leading. They are all lagging while banks, discretionary, semiconductors and biotech are in charge. Bad markets usually don’t begin with this kind of leadership. I will concede that I am concerned about the poor performance in high yield (junk) bonds as they are one of my favorite canaries in the coal mine.

In short, I believe we are in for more of the same for now. Stocks remain range bound where strength can be sold and weakness carefully bought. In the very short-term, there is enough to support a rally in stocks beginning today or tomorrow. I don’t think it will go very far, but for the nimble, it’s worth watching. Should stocks not be able to head higher by the end of day on Wednesday, I would take that as a sign of more weakness and a potential downside break of the smaller trading range. On the Dow, that’s 17,600.

Eventually, I continue to believe that the ultimate resolution of this multi-quarter period of sideways movement is higher on the way to Dow 20,000.

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Two Market Scenarios for the Quarter

In the last issue of Street$marts, I wrote about stocks being in a “murky” period for the next few weeks. I am going to pat myself on the back and say it has certainly looked “murky” since early October although I wish I had been more aggressive in taking action. The dark clouds have recently dissipated and the sun is starting to pop out. Once the decline began, it looked like the second half of October would see a low and that’s been confirmed.

I recently shared research that indicated a 15% chance of a 8-11% decline during the Q4. This was based on the S&P 500 seeing a fresh high in September or October which usually insulates the market from much more than a 10% decline. So far, on a closing basis the Dow and S&P 500 have dropped almost 7% and 7.5% respectively, and 8.6% and 9.4% on an intra-day basis. The other major indices have seen more significant weakness.

Either by skill or luck, I am always happy to nail a low as it occurs, especially now, when so many others were calling for much more serious damage. With the world fixated on Ebola, Europe’s economy, earnings and ISIS, fear was prevalent last week, the likes of which we haven’t seen since mid June and in some cases, 2011.

So far, all we know for sure is that “A” bottom was achieved. Whether it was “THE” bottom remains to be determined. If prevailing sentiment becomes “sell the rally”, the upside is likely to continue. However, if the masses believe that we just saw the final bottom of 2014 on the way to new highs, a more difficult path will be in store as I discuss below.

I continue to watch two scenarios as the most likely paths over the coming months. The green line in the chart below is obviously the more bullish of the two. It has last week’s low as “THE” low from which the year-end rally has already launched and all time highs are to be seen within a few months. The orange line forecasts a lot more volatility with the currently rally petering out shortly and marginal new lows seen within a few weeks. From there, the real rally begins, similar to 2011, with higher prices down the road.

 What is obviously missing from the scenarios above is a truly bearish one that has the bull market already over and this current rally representing a good selling opportunity leading to sharply lower prices right into the New Year and beyond. At this point, I just don’t see it. We simply do not have enough dead canaries to warrant such a negative outcome. And speaking of dead canaries, I will update the Canaries in the Coal Mine next week.

For now, the takeaway is to watch for signs that the rally is hitting stumbling blocks. High yield (junk) bonds had a truly epic day on Friday, recovering five days worth of declines in one day. That nascent advance must live on. Good sector leadership needs to emerge and not from consumer staples, utilities and REITs. Although the banks are a bellwether sector, the bull market can live without them for a while longer, but that will likely lead to the eventual demise.

Before I finish this article, there are things that concern me. It’s not all roses out there! After 67 months, the bull market is showing its age. Traditional Dow Theory just gave its first negative trend change in some time as both the industrials and transports closed below their August secondary lows. That’s long-term problematic unless both make fresh all time highs in the coming months. What would bother me even more is if one index scores a new high, but the other one does not. Anyway, we have time to explore this further next week.

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BOOM! Now High Yield is Key

What a great day in the city on Wednesday! I knew I was okay when Metro North actually ran on time to start the day. I did two segments with the good folks at Yahoo Finance, one discussing the most overused word in investing, “bubble”, and the other on the current state of the bull market. As they are posted I will share the links.

I headed to the floor of the NYSE in the afternoon for a quick stint with Bill Griffeth on Closing Bell. Since the 1980s in the FNN days, I have always been a big fan of Bill’s and I really enjoy chatting with him. The floor was crazy busy and I could hardly move around. It wasn’t, however, from floor traders and professionals doing business. There all kinds of groups visiting and moving around.

Finally, Fox Business’ Making Money with Charles Payne was my final stop and I got to spend a full hour on the show with the other guests. That was special and I will post the various links shortly.

Stocks had a huge day on Wednesday, in both directions. After Tuesday’s drubbing, the decline continued yesterday morning before firming into lunch to get back to unchanged. Then the Fed released their minutes and the market took off like a rocket ship. Frankly, stocks were so stretched to the downside to begin with and were already firming into the news. Yellen & Co. just threw gallons of gas on a tiny little fire and the inferno ensued.

At the end of the day the major indices gained back what they lost on Tuesday plus a little bit. I would have liked the internals to be a little stronger, but you can’t have everything.

The big question now is, “Was that THE bottom or A bottom?”

The jury is out at this time, but for sure, the bulls have the ball now. Let’s see where they are at 4pm today. Let’s watch leadership emerge.

High yield bonds funds, one of my most important canaries, all closed down yesterday which is the norm on a day when stocks  take off during the afternoon from a decline. I would be shocked if funds like PHYDX, NNHIX, MWHYX and JAHYX do not show gains when their prices are posted tonight. If these funds are not up at least .20% or more, that will be very worrisome for the intermediate-term.

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Bears Stepped It Up

For most of September, I discussed the very negative seasonal period that ended on September 30. Remember, poor seasonals with strongly negative short-term trends from the Fed and options expiration usually just provide a headwind or accelerant to a market move already in place. The second half of September was certainly a poor showing for the bulls, which is part of the reason October began so weak.

For those who watch the charts, the Dow and S&P 500 visited their 150 day moving average this morning and are trying to bounce right now. The Nasdaq 100 has been much stronger and the S&P 400 and Russell 2000 have been downright ugly. While a small rally would be nice, it doesn’t seem like the final low is in just yet. A more likely scenario would see stocks move a little higher and then sell off once again next week or the week after to what could be the final solid trading low of 2014.

Between now and then, I will be keenly watching how the various sectors behave as well as high yield bonds. There has been much damage that needs repair before another rally to new highs begins.

At this point, the bull market is wounded, but certainly not dead. It’s time for another update on the canaries to assess the bull market’s health and I will try to get to that early next week.

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