Small Caps Burst. Semis & Banks Readying. REITs…

Friday saw much of the same stock market behavior as we have seen lately. The Dow, S&P 500 and NASDAQ 100 continue to act the best although after closing at a 10 day low with the aforementioned indices at new highs, the Russell 2000 finally got off the mat. The small cap index burst higher and it is now at least in a position to lead into January which would be fitting in well with historical norms. Over these final two weeks of 2017, I certainly would not be surprised to see the S&P 400 and Russell 2000 lead and see all-time highs, even at the expense of the other major indices.

Friday also saw the semis, one of my key four sectors, begin to position itself for another run. Closing at a new high for December would confirm that move. Banks also look like they could be ready for another run higher. Couple that with strong action in the transports and discretionary and you have a market that just doesn’t want to give up any ground whatsoever. Any single day pullback is being bought and investors looking to use up some cash are being punished for waiting. While the media tries to play this up like the Dotcom era all over again, I do not agree at all. But that’s a topic for a different day.

Below is a sector chart which I have been watching (and owning off and on for a while). Once again, REITs, real estate investment trusts, are at the top of a channel for the 5th time. Every other time, it has pulled back. Will this time see a change in behavior???

Finally, following up on our post FOMC (Fed) trend from last Wednesday, it closed out in the plus column as stocks were lower last Thursday, the only day the trend was active.

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What’s SUPPOSED to Happen versus What ACTUALLY Happens

Earlier this week, I mentioned that stocks were coiled up and looking for a big move. Since then, only the NASDAQ 100 has done anything and that was really just on Apple’s earnings beat. Overall, it’s been a very quiet week without any volatility at all. That’s likely to change sooner than later, but unlikely to be today.

As I have mentioned over and over, the post-BREXIT thrust, pullbacks are likely to be shallow as the masses were caught off guard and are now clamoring to buy. Those waiting for a 10% correction will probably be waiting a while unless an exogenous event hits, in which case, they won’t buy anyway!

The government reported that Q2 GDP clicked at 1.2%, well below estimates of 2%. I won’t rehash my long-term theme about the typical post-financial crisis recovery which I have been spot on about since 2009. On a day like this, I always find it instructive to see what’s supposed to have versus what actually happens. Treasury bonds should rally. The dollar should fall. Gold should rally. Crude oil is a toss up.

On the sector front, utilities, staples, REITs and telecom should lead as they are all defensive and provide yield. Industrials, materials and discretionary should lag as they more economically sensitive. High yield bonds should lag.

Let’s watch what bucks what is supposed to occur for signs of change.

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Bears Knocking on Door Again

The major stock market indices are under pressure for the second day in a row, potentially threatening to close below last Friday’s low which is a line in the sand I spoke about on Monday. We will see what happens after 4pm. The selling continues to look orderly and there is not much internal damage being done to the market so far. Semis and banks concern me the most as the bull market can survive without either but not both. Most of the other sectors are pulling back as you would expect, but the defensive groups telecom, staples, utilities and REITs are firming. High yield bonds remain solid but that can change quickly.

The currency market has probably seen the most action with the dollar seeming to put in a low on Thursday. After an 8% decline since December, there is a lot of room for a bounce. That means that currencies like the Yen, Euro, Loonie and Aussie should see weakness, possibly significant, over the coming days or weeks. That would also mean a soft patch in energy prices.

Lots going on right now and volatility is on the upswing!

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All-Time Highs in Sight

This is it.

Put up or shut up time for the Dow and S&P 500.

Both are positioned constructively to power to all-time highs over the next week. And I think they will. With sentiment mixed, it’s hard to believe that there will be any mass celebration of new highs, especially with the index problems I discussed here. In fact, I think there is very little chance that the three other major indices will confirm the Dow and S&P 500 at new highs. This is all part of the stock market transitioning to the final stage of the bull market which could last months, quarters or even a year or two.

Leadership has changed as I discussed on Yahoo Finance, yet few are embracing it. Energy, consumer staples, utilities and REITs are now heading the charge. Previous leaders have gone from buying the dip to selling the rally, which is forcing me to opportunistically rebalance portfolios.

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Stocks Remain in Pullback Mode

With the major indices down 4-8% I am once again getting questions whether the bull market has ended and a multi-year decline is unfolding. I don’t think so.The New York Stock Exchange Cumulative Advance/Decline line recently scored an all time high. When bull markets end, we typically see this indicator peak months, quarters or even years before the Dow and S&P 500. The same can be said of the high yield bond sector. Bear markets are usually associated with restrictive monetary conditions and excessive valuations. It’s very hard to argue we are seeing those right now.

This decline continues to look like a pullback, meaning less than 10% in the Dow and S&P 500. It will end when the weaker bulls give up hope and thrown in the towel, something that has not happened yet. Sometimes that takes a few weeks while others it takes months or even quarters. Remember, my 2014 forecast called for a digestive type year like 1992, 2004 and 2007. That’s what we have seen so far.

Stocks are very oversold in the short-term and on their way to oversold in the intermediate-term. However, as we saw on the way up, overbought and oversold can get more overbought and oversold until a reversal takes hold. Just watching the volatility (fear) index, VIX, breach 20 should give us a hint that the decline is coming close to the end. We have already seen volume in inverse ETFs begin to spike which indicate that investors are running for downside protection.

What’s making headlines right now is the veracity of the decline in the former high flying market leaders like biotech and Internet. Those sectors led on the way down and I am keenly watching them for signs of stability and life. I am also watching them because we now own sizable positions in our sector program. It’s too early to tell if they have peaked for good, but once the market bounces, these should rally hard.

It doesn’t look like the stock market has hammered in a good bottom yet. The typical pattern would see a rally that lasts more than a day or two followed by another decline below the previous low. Today was only day one of a rally. Aggressive and nimble traders can look to sell a 1% rally and try to buy again at new lows, but that should only be contemplated for traders who can sit and watch and have a plan. Otherwise, there should be a better buying opportunity this quarter. Investors continue to hide in consumer staples, utilities and REITs on the equity side and my favorite investment that everyone hates, long-term treasury bonds which we happily have a big position in our global macro strategy.

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U-G-L-Y Day on Thursday

The stock market had a very rough day on Thursday with all of the major indices breaking down below all short-term support levels for the chartists out there. There is no other way to characterize than UGLY. Keep in mind, however, that so far, all we have seen are 3-6% declines. It feels much worse because we saw two large down days over the past week, the likes of which we haven’t seen all year, including the January pullback.

On the sector front, all of the old leaders have taken it on the chin and have been in gear to the downside. New leadership has emerged from REITs, utilities and staples with energy, industrials and materials hanging in impressively so far. This continues to look like the market rotating to the next and perhaps final stage in the five plus year old bull market.

I haven’t said this in a long time,  but Friday is a “key” for stocks. Early weakness is better than strength as long as selling does not accelerate during the day. If we see a weak opening that firms during the day, that will go a long way to stemming the tide for the bulls and setting up a potential bounce next week. On the flip side, another day of torrential selling sets up some rather nasty and dark scenarios…

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2014 Fearless Forecast

It’s really embarrassing that it’s been almost two months since I began speaking about my thoughts for 2014, yet I have been unable to mass distribute them. Shame on me! So far, to those folks who have read them, the comments and questions have been great. Keep them coming!

Regular readers of Street$marts and this blog won’t be surprised at most of the forecast, but I did throw in a few new items. As always, I had a lot of fun thinking about it and creating it, although it has no bearing on how we manage money for our clients.

U.S. Stock Market – After an epic 2013 for the stock market, what can we expect for an encore? To begin with, it’s a mid-term election year and the second year of the president’s term. Historically, that hasn’t been so kind to investors with some of the largest declines in history as well as the end of some bear markets. More recently, however, 2010 and 2006 were kind in the end, but volatile during the year.

Looking at the big picture, there are no signs yet that the old and wrinkly bull market is ending anytime soon and my analysis still has upside projections to at least 17,000. We typically see a number of warning signs with various leads times, but only one of those are in place today and that may be corrected. Those warnings signs may set up later, but at this time, stocks remain the place to be on any dips. With that said, a routine, normal and healthy 5-10% bull market pullback should be seen during the first quarter that leads to more all-time highs later in the year.

On the index front, although the major US indices are highly correlated to each other, it’s time for the Russell 2000 index of small caps to cede leadership to its large and mega cap cousins.

U.S. Stock Market Sectors – Technology is usually the group of choice each January and I continue to rank it as a market performer at best. I wouldn’t run out and load up on this sector unless we saw a sizable market correction. As the economy and markets are late in the cycle, sectors like REITs and energy should provide solid relative performance, especially later in the year. Even perennially hated utilities should grab a bid.  With my long-term positive stance on the dollar, it makes liking commodities more difficult but I do believe 2014 will reward buying the dip and selling the rip in this area.

On the wild side, biotech, pharma and healthcare should go parabolic during the first half of the year with the social media group also a possible candidate. Investors should keep in mind that parabolic rallies like the Dotcoms never, ever end by going sideways to rest.  They end in disaster and ruin like we saw with crude oil in 2008.

It’s rare for me to really hammer on sectors in the annual forecast, but after five years of strong outperformance, I am very negative on consumer discretionary and retail. I think 2014 will be the beginning of the end for this trade and similar to my stance on the small caps in general, I would pair this with a long in large or mega caps.

All in all, 2014 looks to be more of a digestive year, like 2011, 2004 and 1992 than a full fledged bull or bear year.

Volatility – There are many ways to discuss volatility, but the one that resonates well with me is that of a sine wave. It moves fully from one side all the way to the other, like a pendulum. While the market may not operate so neatly, low periods of vol are usually followed by higher periods of vol and vice versa Put another way; volatility compression leads to volatility expansion and volatility expansion leads to volatility compression.

2012 was largely a non volatile year, but 2013 was downright boring from a volatility standpoint. That can be traced to the Fed’s QE Unlimited, which will be going away. So 2014 looks to be a whole lot more volatile than 2013 and probably 2012. If so, that will likely lead to 2015 being even more so as volatility normalizes.

In short, the investment play is to buy vol anytime it heads back to the low end of the range and sell it into spikes, which there should be many.

Long-Term Treasuries -I am so beyond sick and tired of hearing the pundits proclaim that “bonds are in a bubble”. Statements like those absolutely wreak of ignorance. Bubbles are all about greed, clamoring and fear of missing the boat. They are formed in many stages with the final one being a total rush into the asset, primarily by the public. During the modern investing era, new products are launched to give greater access to Main Street. Your neighbors all own the asset and it’s all over the media. There is nothing about bubbles that has pertained to the bond market and there never will be.

The secular bull market in bonds may have officially ended in mid 2012,  but that doesn’t mean and shouldn’t mean that interest rates are heading higher in spike fashion. Clearly, over the coming years and decades, rates will normalize and head back to mid single digits unless the Fed makes a huge blunder like the Arthur Burns led Fed did in the 1970s.

I envision rates heading higher like we saw in the 1950s and 60s, slowly and gradually. Two steps up and one step back. We have already seen the 10 year note yield double as the first stage of the bear market began. I do not believe we will see anything close to a doubling anytime soon. Rather, as I first wrote about and publicized last November, bond market sentiment had become so negative that a rally in bond (decline in yields) wasn’t too far off.

For 2014, the bond market should offer a solid risk/return profile, at least for the first half of the year as inflation remains nearly non-existent, our economy slows and Europe deals with deflation, all against the backdrop of the Fed reducing its purchase of treasuries, for now. While the 3.50% to 4% area on the 10 year looks like a good intermediate-term target, it should not get there right away and investors should not become perma bears on bonds.

Corporate bonds – This group has seen a much stronger rally from their 2013 lows than their treasury cousins, but still behaves well and should see strength during the first half of 2014. Further down the risk spectrum, high yield bonds will continue their 2013 position of lagging and underperforming as the slightest ripple in the liquidity stream could upset this apple cart quickly.

Dollar – I am posting the exact comments as I did last year. Since THE bottom in 2008, the dollar has been in a trading range which I have stated is the beginning of a new, long-term secular bull market. Anyone who has bought strength or sold weakness has been punished and that’s likely to continue for a while before the greenback finally breaks out above 90 on its way to target number one at 100 over the coming years.

I remain very bullish on the buck long-term and believe it can be bought into weakness for a long time, especially given the Fed’s exit from QE, the ramping up of QE in Japan and the anticipated QE in Europe.

Gold – The yellow metal’s secular bull market is not over and it will take another year or so to reinvigorate it. Gold saw twin price lows in the $1180 area that should lead to test targets of $1360, potentially $1440 with a chance of seeing north of $1500 before ultimately turning lower again. When the ECB hops on board the QE bandwagon, look for gold to break out above $2000 later this decade on its way to $2500 and higher.

Commodities – I continue to favor the agricultural and tropical commodities like wheat, corn, beans, sugar, coffee and cotton over the rest with corn being among the candidates for trade of the year. They have been under pressure for a while and weakness should be viewed favorably.

Inflation – I still feel like a broken record year after year after year after year, but I don’t have many concerns about inflation, at least not until we get to the other side of the next recession. The Fed is trying to engineer some healthy inflation, very unsuccessfully I might add. $5 TRILLION in QE didn’t produce any. Money velocity continues its downward spiral. Housing prices are stable. Wage growth is essentially zero and the banks are holding trillions of dollars on reserve with the Fed. This economy still has rolling whiffs of deflation, but nothing compared to the outright deflation in Europe and Japan.

Economy – As we start another new post financial crisis year, no one should be shocked to learn that the masses are positive on our economy yet again with projected GDP growth rates in the mid 3s. I think I have said it every year since the recovery began, but I will repeat it again. We are living through the typical post financial crisis recovery that teases and tantalizes on the upside and worries and frets on the downside. As with other post financial crisis recoveries around the globe, our economy will not return to an historical sense of normalcy until we get to the other side of the next recession.

Federal Reserve – It’s a whole new ball game for the Fed in 2014; or is it as Janet Yellen takes over for one of my financial heroes, Ben S. Bernanke. I believe history will judge Bernanke as the single greatest Fed chair of all-time who should have been given hazard for having to sit and endure so many hours in front of the incompetents in Congress.

With all of the permanent voting members but Jeremy Stein in the dove camp, Richard Fisher and Charles Plosser will have their hawkish hands full this year dissenting on any vote that doesn’t involve continued tapering. Keep in mind that Fisher, Plosser and Jeff Lacker were the three amigos who fought cutting rates and turning on the fire hoses during the summer of 2007 when the sub prime crisis was unfolding.

The Fed’s multi-year money printing program or QE will sadly come to an end in 2014 reaching my longstanding target of $5 trillion. I vividly remember throwing out that number almost four years ago on CNBC’s Squawk Box and was almost laughed off the show. That one comment generated more emails than any other forecast I have made on TV.

As I have said for more than a year, I absolutely do not believe the Fed should even consider tapering until we get to the other side of the next recession, even though QE is having diminished results. It’s the wrong thing to do at the wrong time. It was wrong in 1937 and that caused the Great Depression Part II. It was wrong in Japan more times than I can count over the past 25 years. The Fed should not stop QE.

Obviously, I am also 100% against even considering raising short-term interest rates at all in 2014 and likely much longer into the future. I am sure the three amigos of Plosser, Fisher and Lacker are foaming at the mouth in anticipation of higher rates, but if history has shown us anything about these bankers, they are usually dead wrong.

Unemployment – If you told me that the unemployment rate would fall towards 6.5% in 2013, I would have fallen on the floor and passed out from shock. The economy would have to have grown at 4% or more. Had I any inclination that the labor participation rate would fall to levels not seen since the mid 70s, I would have questioned the accuracy of the government’s numbers. Both occurred last year and those trends should continue in 2014 creating a conundrum for the Fed and economists. The raw unemployment number is strong, but certainly not for the right reasons.

Japanese Yen – And I thought Bernanke’s QE was the greatest financial experiment of all-time. Silly me! That title now belongs to the Bank of Japan. Not only is the yen in a confirmed bear market after a 15 year secular bull market, but the Bank of Japan remains committed to an historic money printing program that will dwarf that of the Bernanke Fed.

It’s Abe, Abe and more Abe. The yen has much, much farther to fall and all rallies can be sold until further notice. The BoJ has learned from their mistakes of the past when they prematurely ended QE. Look for them to go overboard in hopes of ending what has essentially mounted to 25 years of economic malaise and rolling bouts of deflation.

As the world saw in the previous “greatest financial experiment of all-time” with leverage, mortgages, artificially low rates, the alphabet soup of exotic financial products that no one understood and on and on, they rarely end well. Long-term, I have serious doubts, but for now…

Japan – If the Bank of Japan is going to print baby print, it’s very difficult not to be positive on the Nikkei for 2014. If their economy doesn’t respond quick enough or if their markets fall too fast, the BoJ will just crank it up a notch until it works. I remember arguing on TV that investors should never fight with the guy who owns the printing press and that certainly holds true in Japan. The Nikkei should be a leading developed market index in 2014.

Europe – Euro zone problems are far from over, but have taken a breather over the past year. ECB chief Mario Draghi’s jawboning to save the Euro currency has certainly worked in the short-term with sovereign bond yields declining precipitously in the PIIGS countries. At the same time, however, austerity is causing all sorts of economic issues with deflation being chief among them. If that genie gets out of the bottle in meaningful way, look out below!

Additionally, all is not well beneath the surface as a major, major crisis looms in France possibly late in 2014, 2015 or even into early 2016. Germany was certainly not happy about the bailouts in Greece and Cyprus or the ECB programs designed to save Spain and Italy.  The big test comes when the Germans have to figure out how to save a country that is too big to fail and too big to save. I smell a constitutional battle brewing to allow the ECB to outright print money.

Emerging Markets – Coming off an horrific 2013, emerging markets begin the new year on their heels with continued unrest, currency dilemmas and slowing growth. I will go out on a limb and forecast that the sector sees a significant low in the first half of 2014 and outright leadership and strength during the second half of the year led by the secondary countries. The macro trade would be owning a broad emerging markets ETF against a short in the US small caps.