Bulls Remain Large and in Charge Despite Pullback

We had a lot of negative news between Friday’s market close and Monday’s open, almost all on the geopolitical front with the vast majority surrounding President Trump. Of course, Deutsche Bank finally agreeing with the markets that they needed to raise capital was icing on the cake. In a weak market, that backdrop would have yielded a 1-2% lower opening on Monday. In a strong market, we’re talking about .25-.50% lower.

Stocks are due and have been due for a pullback or at least a pause to refresh. That looks like what’s happening right now. With so many investors on the outside looking in, any weakness should be mild and followed by further strength until more serious cracks in the pavement develop. I found it interesting that CNBC’s Fast Money midday report was all about the Trump rally ending. I think those pundits will regret those words.

As I watch the major indices and sectors come off their morning lows, I can’t help but notice that high yield bonds are not following suit and lagging. One day or a few days means absolutely nothing, however, should stocks rally with junk bonds falling, I would become more concerned.

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Volatility Genie Trying to Pop Out

After what has been celebrated as this huge, epic rally on Wednesday, the major stock market indices gave back all of their post 9:30am gains and then some on Thursday. I mentioned the other day that volatility compression leads to volatility expansion and vice versa. When the volatility Genie finally gets out of the bottle, we will probably see a sustained increase. I think we’re close to that now. Please remember, volatility does not always mean decline. It means wider price movement in both directions.

Right now, the important takeaways from the week are that small and mid caps look the most vulnerable, relatively speaking. All of the indices remain overbought and stretched but I do not see a large scale decline unfolding. Emerging markets and commodities are under pressure with gold clearly failing at its 200 day moving average. I wrote about oil peaking the other day and the decline may be starting. High yield bonds and the NYSE Advance/Decline Line continue to act well which should buffer the downside. Three out of four key sectors scored fresh highs this with semis very close although banks saw a nasty reversal from new highs on Thursday.

Altogether, this behavior remains very typical of bull markets. Weakness should be bought.

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Sector Leadership Remains Very Strong

This is going to be a quick update as I am standing at the gate in Hartford waiting for my delayed flight to board. It’s never a good sign when early morning flights are late. I am heading down to the east coast of Florida for a quick trip to visit clients and maybe even hit a few golf balls in between meetings if my back holds up.

Let’s get the theme out of the way early. The short-term still looks overbought and extended, something I continue to say, however the intermediate and long-term remains strong. The GOP, Trump, Paul Ryan inspired rally is not over! Just remember that overbought/oversold and extended can always become more so in the strongest markets. Buying weakness is the correct strategy as I have discussed for a while, until proven otherwise. Looking at the S&P 500, a pullback to the 2310-2315 level seems the most logical.

While all of the major indices have had glorious runs, the NASDAQ 100 has been the strongest and most extended this quarter. This was the index I spotlighted during the first week of 2017 as one that had the best potential to start the new year. Now it has the greatest risk of underperformance. As I look for other index opportunities, Europe looks the most appealing as a laggard play.

Turning to the four key sectors, while they are all leading and look fine, semis have rallied the most and are a bit stretched here, followed by consumer discretionary. Banks appear to be consolidating again before another move higher and the transports bring up the rear, but are by no means behaving poorly.

Tomorrow, I will discuss the divergence in crude oil and the energy stocks. I tried loading the charts through the plane’s WiFi, but that’s just not happening as I finish this on board a very bumpy flight. Longtime readers know how much I hate turbulence and how it seems to follow me on the road. At least I will be in sunny and warm Florida for a few days with a bevy of good restaurants lined up.

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