Small Caps, Semis & Junk Leading. Banks Looking Sick

Stocks ended last week on firm footing as the bounce saw four nice days. With more North Korea tensions in the air, it will be interesting to see if the stock market finally cares or just uses this as an excuse to open mildly lower. Very quietly as I have mentioned before, the Russell 2000 has been leading the major indices. That does have bullish implications if it holds on.

Additionally, the semis which have been the only key sector leading, are one strong day from new highs.

One sector that has me particularly concerned is the banks. They look sick. While that isn’t likely to have a short-term impact, it’s something that must be watched over the intermediate and long-term.

Turning to my favorite canary in the coal mine, high yield bonds are behaving more like semis than banks, trading just one good day from new highs. It would make me feel a whole lot better if this key group can score new highs before rolling over again.

Once again, we have a number of crosscurrents. If stocks gather themselves and rally, I think there will be a good opportunity to sell at new highs. Should stocks rollover first, I will become more concerned about the downside. In either case, I do not think stocks are blasting off higher until next quarter.

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Crosscurrents Abound. Enough for Bulls & Bears

Stocks continue the bounce they began two weeks ago and the same one I have been discussing. Tuesday was the day where the acceleration started. That could be slowing today. The NASDAQ 100 sits an all-time high but it’s lonely up there. The Dow and S&P 500 are within striking distance but the ever improving S&P 400 and Russell 2000 are not close. With the monthly jobs report out this morning, any strength will create a little short-term headwind for stocks into next week.

Speaking of the employment report, it was a little weaker than expected and last month was revised down a bit. This data will be very important to watch for signs of a possible peak. Topping out this year could put us on recession watch sometime in 2018 if the Fed doesn’t pull back their tightening cycle.

I have been writing about the importance of the semis to put the market on its back and lead as it’s the only key sector that is strong right now. This group is now within a good day or so of new highs, chalking one up for the bulls. On the flip side, discretionary, banks and transports are nowhere near that strong, creating a vacuum of good leadership. Healthcare and biotech are cranking at new highs, but those are not usually the sectors that can lead a new leg in an old bull market.

On the flip side of the flip side, high yield bonds have quietly been strong for two weeks and doing their best to recoup Q2 damage and remove themselves from being a concern. Basically, we have lots of crosscurrents right now. Let’s see if the NYSE Advance/Decline Line can make a new high.

If you missed my segment on ABC in CT yesterday regarding market reaction to Harvey, here it is.

Analyzing stock market behavior after disasters

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Q2 GDP Baby. Stocks Like It!

This morning, the government reported that the “second look” at Q2 GDP grew by 3%, higher than the original 2.6% first reported. 3% is even higher than any of my most bullish models and it continues to show that the US economy is re-accelerating higher this year.I would love to hear from all those people who challenged my bullish view of the economy or called me out Twitter. They kept telling me that 3% was a pipe dream.

My theme all year has been reality over rhetoric and this epitomizes it. You can call it coincidence. You can credit Trump or Congress or the global central banks. I would say it’s probably all of the above. The fact is that the economy is doing better than at any time over the past three years and should continue to improve with some slight adjustments and volatility from Hurricane Harvey.

Stocks opened sharply lower on Wednesday after North Korea fired a missile over Japan. However, by the end of the day, the bulls stepped up and regained all that was lost and then some. While I still believe stocks are in an intermediate-term trading range, short-term action is certainly strong and the rally that began at the open on Wednesday should continue. With banks, transports and discretionary still not leading, the rally may very well rest its hopes on the semis. Let’s see if they can score a new high for this quarter and possibly challenge their 2017 highs. That’s a stretch, but don’t count them out.

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Bounce to Continue. Yellen, Draghi & Harvey

We have several crosscurrents to end the week. Before I get to them, while I believe that stocks remain in pullback mode, I do not think that the bounce I wrote about on Tuesday is over just yet. There should be some more upside left. I am slightly encouraged by the very short-term strength in the Russell 2000 although it is about to test the underside of its long-term trend, also known as the 200 day moving average. That could cap the rally. Semis continue to hang in and refuse to tip their hand. On the other hand, transports broke down yet again this week and that’s a drag.

This is all within the context of the slowest activity of the year next week. “Slow” does not mean quiet nor lack of action. There have been many market events when participants have been on vacation. Russia’s debt default in 1998 is among the worst. It pays to stay vigilant.

The Fed’s annual retreat in Jackson Hole Wyoming is happening now. Chair Janet Yellen and ECB Chair Mario Draghi are both set to speak today. If any major policy moves lie ahead, I would expect a little hint in their speeches. Additionally, Yellen could/should offer some clues on the expected tapering of the Fed’s $4+ trillion balance sheet.

On the weather front, Hurricane Harvey is set to hit the Texas coast shortly. The worst forecasts have it making landfall and then pulling back offshore for another assault on land. Weather events are very short-term and quickly reversed market events. The energy sector is where we typically see the highest impact. I wrote about energy yesterday and I still feel the same way, storm or not. Thoughts and prayers are with all those in harm’s way! Stay safe!!

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Bounce Coming But Pullback Still Secure

While the short-term pullback continues, stocks are seesawing back and forth and are “supposed” to bounce here. For the past two trading days, the bears were unable to follow through from Thursday’s decline and fought the bulls to a draw. Unless we are looking at something bigger on the downside than I expect, we should see the bulls step up in a small way. It will be interesting and perhaps telling to see which of the major indices lead and lag the bounce. Both the S&P 400 and Russell 2000 are still in the doghouse.

On the sector front, it’s an uglier story with only the semis remotely hanging in. Banks and transports are already breaking down and discretionary isn’t too far behind. Only utilities look strong here and that’s not what should be leading if the rally were on solid ground. Should the semis lose it, I would think the overall stock market decline to quickly resume to its next downside level, roughly 3% lower.

Looking at my favorite canary in the coal mine, high yield bonds are trying to make a higher high, however I do not believe it’s going to hold. Momentum on down days just overwhelms up days and the intermediate-term pattern isn’t inspiring confidence.

There are more than a few cracks in the pavement which need to be repaired before the next rally begins. I would use little bounces to reposition portfolios. I would not chase stocks higher.

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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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Energy Collapse. An Opportunity?

Stocks continue to bounce after the tensions with North Korea have quieted for now. As I have written about before, I think the stock market used North Korea as its catalyst or excuse to pullback. The underpinnings were a little weak and a little decline was coming regardless. My thoughts remain the same that the pullback is not over and the major indices will need to step it up sooner than later to revisit the old highs.

Every now and then I have mentioned the energy sector this year as it has been under what seems to be constant pressure all year. A few times, I saw short-term opportunities that never transformed into anything more. With this latest bout of selling the sector is once again approaching a window of opportunity. I say “approaching” as the opportunity is not here. I think we need to see the baby thrown out with the bathwater so to speak. It would be great for that to coincide with a piece of particularly bad news for the sector. You know. The things that bottoms are made of.

For now, let’s just watch the XLE ETF day to day and see if the opportunity sets up in a way where risk can be defined. It’s unlikely that it will quietly find a low with this kind of carnage.

Tomorrow, we will look at how crude oil is trading vis a vis the the energy stocks.

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Big Day for the Bulls But No All Clear Yet

Stocks bounced very strongly on Monday led by banks, semis and transports which just happen to be three out of four of my key sectors. That’s one for the bulls. The beaten down Russell 2000 index of small caps led the major indices higher and that’s another good sign for the bulls as the Dow Industrials definitely lagged the rally. While participation was decent, the number of stocks hitting new highs and new lows was not encouraging as they were almost equal. That’s one for the bears.

Given that all five of the major indices closed above last Thursday’s high, the rally should continue today, at least until lunch. High yield bonds did not have a stellar day on Monday and they are supposed to step up today. “Supposed” to is the operative word.

I do expect the bears to put up a fight before new highs are seen. That little battle will certainly go a long way into concluding whether my call for the pullback to continue is right or wrong. I also believe that tensions with North Korea are on simmer and will reignite over the coming month.

I tweeted about the Dow Transports on Monday which you can see below. This is not a new chart. I have been discussing it for the past few weeks as potentially a leading indicator for stocks. This sector was the first to exhibit weakness and then test the blue line which is its long-term trend, aka the 200 moving average. At the end of last week, the transports once again revisited its long-term trend and tried to reverse. On Monday, the group powered higher and confirmed a bottom of potential significance is in place. The upside target for this move is 9600.

The interesting “tell” will be if the rally fails in the transports and closes below the Q3 lows. At that point, we will watch to see if any other indices follow suit.

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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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North Korea was the Excuse

While North Korea is now front and center in the mainstream news as well as the financial news and the financial markets are now fixated on North Korea, the stock market was already positioned to retreat for the past few weeks. It was just looking for a catalyst. I started writing about the likelihood of a pullback beginning in late July as you can read, HERE, HERE, HEREĀ and HERE. As you know, I have been resoundingly bullish all year and targeted Dow 23,000 by Q4 which I pushed back to Q1 2018. This is not the case of a bear who has been wrong just getting louder. It’s the most negative I have been all year although as you will read, I am still not calling for anything dramatic on the downside.

Historically, I have pretty much dismissed saber rattling as a one or two day market event where the markets quickly resume their prior trends. That’s been especially true of North Korea as it seemed like they just wanted world attention. The exception was Iraq in 2003 as it became clear it was only a matter of time before the bombs started flying.

Having been in the business for 29 years this month, I have learned enough to fill an entire Encyclopedia Brittanica series. In the late 1990s, I learned a valuable lesson about using 4 very dirty little words. “This time is different.” It rarely is. Regardless of the technology or societal advances, human behavior just doesn’t change. Markets oscillate between fear and greed. Regarding North Korea, I do not have the same feeling as I have had in the past. I know. I know. Feel is not real.

Russia and China both voted with the U.S. and the rest of the UN’s security council on the sanctions. That may not seem important, but remember, Russia occupied North Korea after the war and China was an ally during the war. Until the Soviet Union fell, Russia was North Korea’s protective big brother. In recent times, China has been North Korea’s quiet trading partner. Having both of them vote against North Korea, this is a huge sea change.

Additionally, I have heard through my channels that both Russia and China have amassed and continue to build through troop strength along their borders with North Korea. This is not normal activity and leads me to believe that Russia and China no longer think that Kim is just playing childish games. The two countries are preparing for something militarily. Whether that’s defensive or offensive remains to be seen. I do think that any unprovoked military action by Kim will be responded to very harshly by the U.S., Russia and China. If I lived in South Korea, I would be very worried right now.

I also think that whatever is going to happen with this current incident, it’s happening right now, meaning we are in it already. It could end this weekend with some kind of back door deal or it could escalate over the coming days and weeks. It will be interesting to see how President Trump handles all this. Is he combating a bully by pushing back or is he serious about action? Bluffing? Looking to make a deal? I have always thought of Trump as someone who beat his chest to scare and intimidate, but back down when push came to shove. We will see…

Back to the markets, before North Korea was on the markets’ radar screen, I discussed a number of short-term concerns. Before I get into them, my intermediate and long-term views remain absolutely the same. The bull market is alive and reasonably healthy for being 8+ years old. My next upside target is 23,000 by Q1 2018.

With that out of the way, my short-term worries lead to me conclude that a normal 3-5% pullback is underway. Of course, stocks could overshoot a few more percent, but I do not believe the stock market is in the early stages or approaching a 10%+ correction. The downside risk looks to be over the next month or so.

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