Don’t Count the Bulls Out to Begin 2015

Welcome to 2015! Wishing you and your family a very Happy, Healthy, Safe and Peaceful New Year!

Stocks finished 2014 with a whimper rather than a bang as the lack of liquidity allowed sellers to move prices sharply lower on Wednesday. The last two days of December have become somewhat of a headwind lately, but that weakness is supposed to be reversed next week. As bullish as I was over the past few weeks on the small cap Russell 2000, the trend is now to own the S&P 500 and Nasdaq 100 to begin the year. It’s also the time when the cheap, beaten down stocks from 2014 are supposed to get a bid and see higher prices over the coming 1-2 weeks.

I am sure the bears will come in to 2015 all fired up having won the battle on Wednesday, but I suggest caution in getting too negative too quickly. The time for that should come multiple times this year and possibly as soon as the next  few weeks, just not right now. The first week of so of the New Year usually sees some crosscurrents not limited to the previous year’s leaders being laggards and vice versa. I am focused squarely on the energy sector for signs that trend is taking shape. Crude oil looks like it can bounce to begin 2015, but it doesn’t yet exhibit signs of THE bottom just yet.

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Bear Trap and Dow 17,000

A week ago today, the major indices saw a solid red day that had the pundits talking correction and investors running for cover. One day later, however, the bulls closed the door on the bears, trapping them in some bad selling decisions. From there, the bulls had control right into the Memorial Day holiday and that should spill over early this week.

The Dow has already hit an all time high and the S&P 500 should be soon to follow. Even the Nasdaq 100 could get there before long, but the S&P 400 and Russell 2000 need a lot more help. That has been and remains a thorn in the intermediate-term health of the bull market.

Seasonal and volume trends create some headwinds after the holiday so it will be very instructive to see how the bulls behave on Tuesday and Wednesday. Further strength this week will bode well for a move above 17,000 next month while weakness should just be temporary or create a short-term trading range.

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Major Indices Not Singing a Good Tune

2014 may be young, but so far, it’s exhibiting a very different character than 2013 with the rate of ascent completely flat lining and the high flying leaders hit very hard. In other words, the year has been digesting as I wrote about in the 2014 Fearless Forecast. Don’t get me wrong, just because I forecast this type of action doesn’t mean it has been an easy year to make money. It hasn’t. And I don’t think that changes just yet.

I am going to discuss the five major U.S. indices and see what we can glean from the action in 2014. Remember, the healthiest markets have all five indices in sync, meaning they should all make highs at the same time.

The Dow Jones Industrials are first and you can see highs in March and April with essentially equal lows during the same months. After today, the Dow is within striking distance of all time highs, a positive sign.

The S&P saw a higher high in April than March, but a lower low as well, making it stronger and weaker than the Dow.

The S&P 400 Mid Cap Index is below and while it shows similarities to the S&P 500, it is now exhibiting a series of lower lows as seen twice in March and once in April. As such, it is also farther away from all time highs than the other two indices.

The Russell 2000 is next and here you can see a very different pattern. From the last significant low in 2012, this index has led the market higher almost the entire time through early March 2014. Since that time, we see a series of lower highs and much lower lows. Not only is the Russell no longer the leading index, but it’s action is anything but positive and certainly warning of something on the horizon. For full disclosure, some of our programs took a position here at the lows last week since it was overly stretched to the downside and the odds a short-term snapback.

The technology laden NASDAQ 100 is the last major index to show and looks very similar to the Russell 2000 except it has already retraced the entire February to early March rally. Neither index is anywhere near all time highs and both need to be watched closely.

The S&P 500 is next and the chart looks very similar, to the Dow above. If I were doing a full Canaries in the Coal Mine piece, the above comments would be collectively labeled a dead canary and certainly disconcerting for the long-term health of the bull market. However, the canary can certainly be revived if all major indices get back in gear to the upside later this quarter or over the summer.

In the short-term, contrary to what may be reported, it will not be a positive sign to see yet another high in the Dow and/or S&P 500 without the other major indices confirming that celebration. Until proven otherwise, the higher beta (read weaker) indices are now best viewed as sales into rallies than anything else.

Canaries Still Breathing Okay

I haven’t done a canaries in the coal mine update in a while, but with the major market indices hitting fresh highs last week, it’s time to check if any are dead. Remember, canaries in the coal mine are only useful at bull market peaks and bear market troughs. In other words, they are very helpful at spotting beginnings and endings of bull markets, but not much in between. They are so important because they usually give ample warning that a bull market is living on borrowed time as the canaries begin to die.

Let’s start with the major indices as they should all be in new high or fresh highs for 2013 territory. The Dow is first and you can see the all time from last week on the right side of the chart. 

dow

The S&P 500 (very large companies) is next and it, too, hit all time highs last week.

 s&p

The S&P 400 (medium size companies) is below and it is in line with the first two from above. The S&P 400 is usually the big leader during the mid stages of the bull market as many companies in this index experience their glory years or growth and financial stability.

mid 

The Russell 2000 (small companies) is next it saw all time highs last week. This has been the index leader since the June 24 low and pretty much entire bull market from 2009. There have been a few warning signs along the way, but they keep repairing themselves to health.

rut 

The technology laden NASDAQ 100 is the final major index and it has done a remarkable job at playing catch up, not only in the very short-term (since mid July) but also over the past year or so.

ndx 

In summary, all major stock market indices recently saw fresh highs indicating that the bull market is not close to ending. 

The Dow Jones Transportation Index is below and this serves two purposes. First, it’s a minor index after we look at the major ones. Second, old school Dow Theory offers that the Dow Industrials and Transports should be in sync during major rallies and declines to confirm the long-term trend. At bull market peaks like 2007 and 2000, we usually see one index fail to confirm the other’s price move. In other words, if this bull market were ending, we would either see the Industrials or Transports fail to make their final price peaks together. At this point, that’s not the case.

tran 

Turning to the bellwether sectors, the banks continue to lead and see new highs on each successive push higher in the stock market. This is healthy action. On a separate note as I mentioned on CNBC’s Closing Bell last week, the banks remain one of the most unloved sectors in the market in spite of their huge price gains and leadership role. I am not a fundamental researcher,  but if investors can look past the major players like J.P. Morgan, Citi and Wells Fargo where new government regulation may present some head winds, the regional banks and small banks may present some good opportunities, especially if a mergers and acquisitions wave begins.

banks 

With overall sentiment towards the banks negative, this group should continue its leadership role and be a good buy candidate after market declines.

The semiconductors present a much different picture. They are so vitally important because of their leadership in the technology sector and technology’s leadership in the overall stock market. The semis not only are a long-term canary, but also have some good predictive power for intermediate-term moves, something that would make a good article for the next issue.

 semis

I have to admit that this group can be a bit frustrating at times because it gives more warnings than any other canary and the only warning that really matters for the end of a bull market is the final one. As you can see below, the semis did NOT see fresh highs last week and their price is already creeping back into the range we saw during May and June. This is not good behavior and bears watching closely.

The New Stock Exchange cumulative advance/decline line is next. For newer readers, this simply represents the number of stocks that go up and down each day totaled over time. I have found it to be an excellent barometer of liquidity and overall market health even though its warnings can range from a few months to almost two years as we saw in the spring of 1998. Detractors will point to the number of non operating companies that litter the NYSE, but that’s exactly why I find this indicator so useful. Those non common stocks are typically closed end bond funds (CEFs) that are acutely sensitive to interest rates. The combination of common stocks and CEFs has proven to be a valuable long-term indicator when the major stock market indices march higher without the NYSE A/D line.

From the chart below, we see twin peaks in May and July, a very mild warning with price going much higher, but nothing that indicates impending doom. This is another canary that should be closely watched now.

NYAD2

Finally, let’s take a peak at high yield (junk) bonds as depicted by the PIMCO High Yield Fund. You can use any of the major funds or the ETFs. I just choose PIMCO because it is a very large fund with a long track record. Junk bonds are so important because they are acutely sensitive to ripples in the liquidity stream as well as the economy. They are at the bottom of the credit hierarchy and money typically flows out of the sector at the first sign of economic trouble or decrease in liquidity.

PHYDX 

You can see how the fund made its high in May and sold off dramatically into June. What is unusual is that this decline occurred without stocks cratering. In fact, high yield bonds saw more carnage than stocks. And as stocks vaulted higher in July and August, the high yield sector could barely muster a rally to get back half of what it lost. This canary appears to be dead for this cycle. If junk bonds rollover again and we the PIMCO fund in the mid 9.40s, I think that will spell at least some short-term trouble for stocks. 

In summary, the canaries are generally healthy with only one dead (high yield) and maybe two on heightened observation (semiconductors and NYSE A/D line). Before this bull market ends, I expect to see many more canaries on the dead list.

 If you would like to discuss how your portfolio is acting now or could behave if more canaries bit the dust, please contact me directly by hitting REPLY or calling the office at 203.389.3553.