Like an Elevator

Down big. Up big. It’s like riding the elevator at the Empire State Building. Italy’s banking system goes from being on the verge of collapse to all is hunky dory in 36 hours. The past few days looked a little bit like BREXIT almost two years ago. While I did not believe BREXIT was going to be a huge event at the time, I still think that Italy has the potential to be that sub prime mortgage canary in the coal mine for the next global crisis. We should not stop focusing there.

The bottom line is that stocks remain in the trading range established from the January all-time high peak to the February bottom in the Dow Industrials, S&P 500 and S&P 400. The Russell 2000 and NASDAQ 100 have already exceeded their January highs and I fully expect the others to follow next quarter.

The short-term remains murky. Our shorter-term models are negative. Semis, transports and discretionary behave well. Junk bonds act like something is brewing on the horizon. Both may be right.

The government revised Q1 GDP growth to +2.2%, slightly lower than expected. For the past decade, the first quarter of the year has been weaker, even after adjusting for seasonal tendencies. It’s been somewhat of a head scratcher for economists. However, that weakness does not change my own forecast for much stronger growth in Q2 and Q3. As you know, I am looking for recession beginning between mid-2019 and mid-202, but it should from higher levels of output by the economy. I do not think it’s beginning right here.

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Italy Definitely Matters. Canary in the Coal Mine?

Stocks were “supposed” to rally on Friday ahead of the long weekend. While they did put in a good performance, they still ended in the red. That adds further weight on the short-term negativity of some of our models when stocks don’t behave as the odds say they should.

This morning we woke up to more troubles in Italy. Anyone surprised by this hasn’t been paying attention. In my year-end report to clients as well as in my Fearless Forecast, I listed Italian and Spanish banks as things that will keep me up at night in 2018. Too big to fail, too big to save. I think this remains on the tip of the iceberg. Investors should worry a whole lot more about European banks than anything Trump is going to tweet and saber rattle.

Although I do not think this is anything like the financial crisis and 2007-2009, I do think these banks may be a canary in the coal mine. Remember sub prime loans in early 2007? How about those two Bear Stearns mortgage hedge funds that blew up in July 2007?

Early in the year, you were hard pressed to find many pundits who didn’t think Europe offered better risk/reward than the U.S. And most believed that European banks had much more upside than U.S. banks. While I couldn’t argue with their fundamental conclusions, I also couldn’t join the overwhelming majority in these trades.

Anyway, stocks look to open almost one percent lower, taking their cue from European markets. I wouldn’t read so much into it until we get past the first hour. We have upside and downside reversals still in play. Let’s see if which gets closed above or below first. The NASDAQ 100 and technology are poised to resume leadership as I mentioned last week.

Semis and internet look like they want to break out higher. The same with transports and discretionary. We will have to see about the banks. Energy stocks are oversold in the short-term. They are “supposed” to find a low this week. Junk bonds still stink.

Bonds continue to quietly rally which means lower rates. What happened to all of the bond armageddon pundits who drew all of those absolute and fancy lines in the sand?!?!

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Double Reversal of the Reversal

On Tuesday, Wednesday and Thursday we saw three separate reversals in the major stock market indices. First, there was a “key” downside reversal after a nice little rally, followed by back to back days of stock selling off early and closing strong. Long time market analyst, Walter Deemer, very aptly replied to one of my tweets that it’s not so much the reversal itself, but the action after those wilder, more emotional days.

People love to cherry pick and and point out reversals at major market tops and bottoms because they worked so perfectly. However, there are many others which see no follow through and the market quickly resumes its trend. My point is that when you see a reversal, it’s time to pay a little closer attention and look for other indicators that support that position.

Stocks are basically chopping sideways with the NASDAQ 100 looking to have the best opportunity for an upside move. The Friday before a long weekend typically has an upward bias so I am watching to see if that fails to materialize and what Tuesday holds. Semis and discretionary are already breaking out and transports are close. Oil looks tired after an epic run but I don’t think the rally is over. After the pullback, energy should see new highs. The energy stocks are a different story. Most bonds are very quietly rallying nicely although junk bonds continue to look like garbage. You already know about my concerns there.

Wishing you a safe and enjoyable long weekend full of family, food and fun.

Thank you to all those who have served our country so courageously, especially those who gave their lives for our freedom.

Paul

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“Key” Reversals. Junk Bonds Still Stink

Let’s start with junk bonds. While they don’t really stink, they are not participating at all in the stock rally. As I mention time and time again, that has little value in the short-term and no predictive power. However, it does matter, and sometimes a lot, over the intermediate-term. My fear, well I am really not scared but rather concerned, is that the final peak in high yield bonds has already been seen. If that’s the case, it doesn’t bode well for the bull market in stocks passed 2019 which would fit in with my thought of recession coming.

On the equity side, while stocks jumped out of the gate on Monday on temporary aversion of the trade war with China, the stock market certainly did  not trade well that day with no index closing at or near the high of the day. On Tuesday, we saw another one of those “key” reversals where stocks open at their highs for the day and close near their lows. It looks ugly on a chart as you can see below in the Russell 2000 Index of small caps which has been the leader. While stocks typically do see weakness after reversals, it’s nothing like the gloom and doom so many technical pundits call for after this one day pattern triggers.

A few of our short-term models turned negative on Monday and Tuesday so I am going to temper my enthusiasm for now. While I remain steadfast that fresh all-time highs are ahead above Dow 27,000, I think some caution is warranted here.

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Pause Ending?

With news out that Trump Tariff Tantrum has been delayed, stocks around the globe are rallying roughly 1%. That’s the expectation when trading begins for the new week. It will be telling to see if all five major stock market indices can score new highs for the month which would give the bulls more credibility. I would really like to see another index besides the Russell 2000 see all-time highs right now.

Additionally, on the far right side of the chart, it’s important for the former technology leader, NASDAQ 100, to at least keep pace on the upside if not lead outright. It will go a long way if this index can close above the light blue and dark blue lines which will set it on a course to all-time highs next month.

On the sector front, semis are doing “fine” but could be doing better. Banks seem poised to lead and score new 2018 highs before long. Ditto for discretionary. Transports, as I mentioned last week, look “juicy” and are also in a strong position to take off to the upside and lead stocks on an assault higher. As I continue to mention, only junk bonds give me cause for concern over the intermediate-term.

Stocks should move higher this week into the unofficial beginning of summer. If they do, I will watch to see if sentiment gets on the giddy side or if skepticism remains. That should tell us a lot about the rally’s duration.

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Small Caps Still Leading But…

The mild pullback/consolidation continues although you wouldn’t know from watching the Russell 2000 small cap index below. This index sits at all-time highs as seen above the dark blue horizontal line as well as breaking higher above the light blue line which has contained price since the early Q1 correction. On the surface things look really good for small caps as they are leading. However, I do think their leadership is close to ending with the other major indices about the step up.

Even beneath the surface with the NYSE A/D Line, things are just fine. Stocks should be insulated from any major carnage for a while. Only the continuing plight of junk bonds has me a little concerned. They just cannot seem to lift their heads at all. While that doesn’t mean much in the short-term, it does have implications the longer this behavior lasts.

I was planning on doing a post on the recent spike in bond yields, but that will have to wait until next week as I am way past my self imposed deadline on an important report to clients.

Have a great weekend.

Hoping that we get two straight days without rain sometime soon!

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Pause to Refresh. Transports Looking Juicy

It looks like Monday’s failure by the bulls put in a short-term peak and stocks will either trade sideways for a bit or pullback below Tuesday’s low. There shouldn’t be too much price deterioration. We have some overbought readings in the major indices so if stocks can resist much weakness, that could speak volumes about the next move which should be to new  highs.

On the key sector front, banks and discretionary are quietly stepping up while semis appear to need a rest. Transports may be the most interesting of the lot as this week was the fourth time they tried to get through 10,850 on that index. My sense is that on the fifth try, this key sector will blast through and head to new highs, perhaps in July or August.

The only significant concern I have now is the same one I have had, high yield bonds. They are not leading and barely rallying. While this behavior can sometimes warn falsely or even warn for more than a year, it’s something to keep front and center as my favorite canary in the coal mine.

In Friday’s piece, I will spend some time on the recent spike in yield on the 10 year Treasury note which has everyone’s attention.

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Nothing Sexy But Still Higher Prices

Since May 3rd, the path of least resistance has been up in the major stock market indices. That is supposed to continue although I will soon be on the lookout for a short-term pause or minor pullback. With the small cap Russell 2000 leading, there has been little to complain about lately, at least for the bulls. While none of the four key sectors are knocking it out of the park, they all look poised to head higher. Energy has been leading as is typically the case at the end of the cycle and bull market with high yield bonds being dragged higher and lagging as we normally see in the latter stages.

As I wrote about last week, the NYSE A/D Line is scoring all-time highs which typically insulates stocks from a bear market for 3 to 21 months. The gains may not be as sexy and sultry as they once were, but stocks remain the place to be over the intermediate-term. It’s time to temper expectations that a rising tide will lift all ships. I fully expect rallies to begin to become more selective.

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Bull Markets Do NOT End This Way

*NOTE: I began this piece as my regular Friday blog post as a follow up to a tweet I sent last night. The more I wrote, the more I wanted to say. That turned into more of an Analysis 101 piece which I am distributing to everyone. It’s also one very important piece in my canaries in the coal mine which I hope to have out next week.

One of my favorite long-term indicators scored an all-time high on Thursday, the New York Stock Exchange Advance/Decline Line (NYSE A/D Line). Before you stop reading, start yawning and move on to another topic, this is one of the better indicators of long-term health for the stock market. For those not familiar, every day, we look at the net number of stocks going up or down on the NYSE. If there are 2000 stocks up and 1000 stocks down, the net number is +1000. From there it’s just a cumulative line as you can see below.

The NYSE A/D Line is valuable because it tells you what’s going beneath the surface of the major stock market indices. Since most of the major indices are weighted by market capitalization or value, they can often mask underlying problems if the biggest stocks are doing fine.

Normal behavior over time shows that the NYSE A/D Line and the major indices like the S&P 500 generally move in the same direction with similar peaks and valleys. When the major stock market indices make new highs but the NYSE A/D Line does not, that’s where bulls should begin to worry. If you look at the chart above, the exact opposite is happening. The NYSE A/D Line is at all-time highs, but stocks are still well below those highs. That’s typically a good sign for further strength in stocks over the intermediate-term.

Bull markets usually end when the NYSE A/D Line peaks and rolls over to the downside long before the major stocks indices do. A good analogy would be that the generals are all still battling but the enlisted men have all died. Or, the foundation of the building is full of cracks and is crumbling but the penthouse looks flawless with million dollar art and furniture.

If you look at all of the bear markets since 1955, which I arbitrarily used as a 20% closing decline in the S&P 500 from an all-time high, you find 9 beginning on these dates:

8/3/1956

12/12/1961

2/9/1966

11/29/1968

1/11/1973

11/28/1980

8/25/1987

3/24/2000

10/9/2007

I could have also added 7/16/1990 and 7/17/1998 as those declines were just short of 20%, but it just adds more credence to the outcome. In every single case except for 1968, the NYSE A/D Line topped out before the S&P 500 although 1966 was only three weeks. 1990 and 1998 did as well. The average lead time was 221 market days or about 10.5 months.

Again, with the NYSE A/D Line scoring an all-time high, that has traditionally insulated stocks from a bear market for at least three months but as long as 21 months. It doesn’t mean that stocks can’t fully correct, but that weakness should definitely be bought. While the masses were exclaiming the end of the bull market during the February decline, I have pounded the table at every juncture that regardless of the decline, fresh all-time highs were coming, at least to Dow 27,000, partly because this indicator peaked with stocks in January as it usually does during healthy bull markets and has not yet diverged.

For those wondering, in 2007 as you can see below, the S&P 500 peaked in October, but the NYSE A/D Line topped out in June, a full four months lead time.

The previous bear market from 2000-2002 saw the NYSE A/D Line peak in mid-1998, a full 21 months before the major stock indices did as I show below. In fact, by the time the Dow, S&P 500 and NASDAQ 100 topped out in March 2000, the vast majority of stocks had already been declining for almost two years. If it wasn’t Dotcom and tech, it wasn’t going up.

While this is a very powerful long-term tool, it is certainly not foolproof nor infallible. It will give warnings that later get corrected without much of a decline in stocks. The NYSE A/D Line will decline as stocks go up, but then regather itself and make new highs down the road. That’s why I use it in conjunction with other tools or canaries in the coal mine.

Finally, naysayers like to argue that the NYSE A/D Line is full of too many non-operating companies which behave more like bonds and therefore the results get skewed. While they are correct, research concludes that including the bond-like proxies is a much better indication of overall stock market healthy than just using the NYSE A/D Line for common stocks only.

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Stock Market & Economy Yawn as Trump Terminates Iran Deal

I have to laugh when I hear so many pundits surprised that Trump withdrew from the Iran nuclear deal. It was one of his many campaign promises. Most members of his revolving door administration were squarely against the deal’s continuation. What was so surprising?

While my interview was 5 minutes, only a few comments made the segment on WTNH (ABC in CT) last night. I don’t think the Iran news will have any economic impact at all. It’s been fairly priced in the markets.

Oil had one of its most volatile days in years as you can see from the ETF that owns oil below. However, counterintuitively, oil did not rally sharply on the news that perhaps Iran won’t be able to sell all of their oil as they have been doing.

The truth is that oil has been rallying for two years from $26 to $70 as I have forecast a few times in my Fearless Forecast. $100 has been my upside target, but I do not believe it is going there during this rally. Oil is at the point where too many people finally believe in the rally. That’s usually the beginning of the end.

The major stock market indices are taking all of the geopolitical news in stride. Consolidation seems to be the operative word as stocks ready for an upside resolution. The S&P 400 and Russell 2000 have been behaving better than their cousins, but I can’t argue with any action over the past 5 days since I wrote about the green shoots.

 

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