Bulls Have Room to Run

Having turned negative on stocks on April 21, I warned last week that our models were close to turning positive again. What I didn’t realize at the time was that it was going to happen just a few hours later and confirmed on Monday. If you recall, I wasn’t expecting anything major on the downside, just some normal and healthy weakness, or a pause to refresh before heading higher again. I did believe that it would be the largest pullback since the rally began in February and that’s exactly what transpired.

On Monday, for those portfolios that take positions in the major indices, we went all in by equally weighting the Dow, S&P 500, S&P 400, Russell 2000 and NASDAQ 100. Other portfolios covered short positions and/or removed hedges as well as added to equity positions. Thankfully, the stock market cooperated on Tuesday and gave us some instant gratification.

As we head into the long weekend, the NYSE A/D line sits at an all-time high. High yield bonds are but one day from new highs. Semis and banks are at new highs for 2016. Sector leadership is solid overall, but not powerful as the transports need to step it up. Sentiment went from a bit too enthused to neutral. That’s just as expected given the mild nature of the decline.

Life is okay for stocks right now and a short-term pause next week won’t be bad.

Gold, on the other hand, is threatening to break down as smart money is at all-time levels of pessimism. Should this occur, I can certainly make the case that a 20% decline could unfold this year into what I would view as the best buying opportunity in years. Given that we run two independent gold equities strategies, I am very much aware of what a gold decline could do to those stocks.

Have a great weekend and a heartfelt thanks to all those who have so bravely served our country!

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Bears Still in Control but Bulls Getting Closer

As you know from the suddenly negative piece below, I temporarily abandoned my bullish stance on April 21. At that time, we significantly raised cash, hedged and/or purchased securities that don’t perform with the stock market.

http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20160501.pdf

At that time and every week since on www.investfortomorrowblog.com, I did not believe that stocks were on the verge of collapse or that a new bear market was unfolding. It just looked like a normal, healthy and much needed pullback that should end up as the largest bout of weakness since this latest rally began on February 11.

On the positive side, selling has been very orderly over the past month and stocks are still not that far from new highs. The chart below is the New York Stock Exchange Advance/Decline line which really just shows participation in the market. A rising line means more and more stocks are going up. This is best used over the intermediate and long-term. As you can see, since mid-February, it has showed a very broad-based and powerful rally without much giveback during the pullback.

My favorite intermediate and long-term canary in the coalmine, high yield bonds shown below, have also been behaving very well and exhibiting the type of behavior normally seen before large declines or bear markets.

What’s impacted our models is the major stock market indices were acting very tired from two months of going straight up, coupled with sentiment looking frothy. By “frothy”, I mean that the masses went from despondency in February to comfort at the end of March to ebullient by April 20. That combination has a high degree of accuracy in stopping the advance and seeing stocks pullback.

Looking at the Dow, another few percent decline would make the market more attractive from a risk/reward level, assuming high yield and the NYSE A/D line didn’t weaken substantially. I also want to see good behavior from at least three of the key sectors, semis, banks, consumer discretionary and transports.

Over the intermediate-term, stocks don’t seem to be poised to blast off to 19,000 should they poke through all-time highs this quarter. In other words, for now, I think that the market’s trading range will continue with strength to be sold into and weakness to be bought. Eventually, later this year, stocks should begin an assault in 19,000 and 20,000 and possibly even much higher.

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Plodding through the Pullback

Not much has changed this week. As has been the case since April 21, I am still looking for lower prices, but nothing dramatic. The selling has been orderly and constructive. The NYSE advance/decline remains very strong and healthy, not what you typically see during bear markets or large declines. High yield (junk) bonds, which we have owned for months, continue to behave very well with oil stable and rising. The major stock market indices are only a few percent away from areas where I would become interested again.

Of the four key sectors, there is not much to glean. They are all okay at best. The rest are scattered with software, energy, industrials, materials and staples looking the most constructive. Retail has performed the worst with new calls, yet again, for recession. I don’t see that happening this year.

All in all, stocks remain on the quiet side, for now.

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“Bounce” Teetering

The “bounce” I mentioned here remains alive although it is living on borrowed time. I continue to believe the ultimate low remains in front of us. Retail and consumer discretionary stocks have been the latest to take it on the chin with a slew of poor earnings from Macy’s Nordstroms, etc. This sector is one of my key vital four groups and it’s important for the bull market’s health to keep the majority of them moving forward. While I do not believe it has short-term implications, I do think that losing leadership from a few of the key four could spell trouble later this year.

For the bulls, it’s very important to see a daily close above this week’s peak to set the stage for an assault on all-time highs this quarter. For the bears, closing below this week’s low along with last week’s more important low would begin the next small leg lower for stocks where I believe the real bottom is. I am also keenly watching high yield bonds as they are acting like stocks and the market needs their leadership.

Besides the aforementioned weak sectors, semis, telecom, banks, industrials, materials and transports are behaving weakly. If the bulls are to mount a charge, we need to see at least some of these groups regain health. The stock market will not hold up with just precious metals, consumer staples and utilities leading the way.

Finally, don’t look now, but the U.S. dollar is threatening to rally hard again. I don’t have the sense that it’s THE next big rally, but it could be a decent one.

Have a great weekend!

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Here Comes the Bounce

The major stock market indices staged an impressive comeback on Friday as they all reversed early losses to close nicely higher. Given the very orderly pullback along with some modest losses of roughly 3% except in the NASDAQ, the odds now favor the bulls stepping up right here for at least a short-term bounce. Should the bounce materialize, the next question will be if it’s a bounce all the way to new highs or just back towards 18,000 before rolling over again.

With the NYSE advance/decline line still acting so strong, it’s unlikely that this indicator will help us much on this rally. High yield bonds, however, is one area that we should very closely watch for clues about the next month. Plainly put, we want to see them head to their old highs, if not outright score new ones. Should stocks rally without junk bonds, my opinion will be that the stock market is in for a deeper bout of weakness this quarter.

While almost every major sector saw a reversal on Friday, not all are behaving constructively. REITs, staples, and precious metals are clearly the leaders, but those are not the usual suspects during healthy advances. Discretionary, industrials and materials have constructive price patterns, that is, as long as Friday’s low was the end of the weakness. Should these sectors close below Friday’s lowest price, I think the stock market would struggle to find other good leadership groups to push it higher.

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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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Bulls then Bears and Finally Bulls

The stock market had a nice little reversal on Friday as the bulls fended off morning weakness to close well off the lows. While I remain in the pullback camp and see lower prices ahead, the bulls should have enough ammunition to mount a small rally here. If Friday’s lows are closed below anytime this week, I would become slightly more concerned than I already am regarding the short-term, but I don’t think that’s the most likely scenario here.

On the sector side, most still look very constructive although semis, healthcare and biotech are the problems. High yield bonds remain strong and the NYSE advance/decline line behaves like a new bull market was just launched as you can see below. For all those perma-bears who continue to wrongly believe that stocks are in a bear market, this one chart below refutes all claims.

NYAD

All in all, the stock market remains healthy over the intermediate-term, but the short-term risk/reward ratio favors the bears a little. Just your typical, routine and healthy pause to refresh.

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Apple’s Collapse as the Market Bears Reign

Just over a week ago and one day after most of the major market indices peaked, I posted a piece entitled Reigning in Bullishness where for the first time since the rally began in February, I tempered my enthusiasm. I couched my negative comments with more sanguine words that I absolutely do not believe the bull market has topped. This looks like a routine, normal and healthy pullback, but also the deepest decline since the rally  began.

It’s been a crazy week with the Fed not raising and not really changing their stance, Apple’s earnings disaster and the Bank of Japan standing pat. As a side note, whenever Apple has problems, it’s amazing how many people come to its defense. When I am critical of the company which I most recently was on CNBC, Has Apple turned rotten, people act as if I attacked them personally. I love the amateurs who think they know more about the company than everyone else. You just have to laugh. Of note, famous activist hedge fund investor, Carl Icahn, publicly disclosed yesterday that he sold all of his Apple stock though he still supports Donald Trump. This was the same Icahn who pounded the table for months and quarters about how wonderful the company was and his bromance with management. Now, citing China concerns, he sells all of his stock as if the entire game changed in his mind overnight. I guess Carl couldn’t Make Apple Great Again!

Anyway, getting back to business today is also month end where we can sometimes see portfolio games. The NASDAQ 100 is now down five straight days which usually means a bounce is coming. Sector leadership remains constructive with the defense groups, staples, utilities and REITs under pressure. Healthcare and biotech are head shakers as they finally got into a leadership position after several quarters of faltering, only to roll over again this week.

Unless high yield bonds roll over and begin to underperform, I remain in the camp that we will see a buying opportunity sometime in May. For now, junk bonds remain long and strong.

Have a good weekend!

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The “Secret” Reason Yellen Doesn’t Want to Raise Rates. Special Fed Meeting Update

I believe there is a “secret” behind the Fed being slow to hike short-term interest rates. I will get to that in a minute.

Today’s Meeting

Let’s start with non-controversial items first. The Federal Reserve Open Market Committee concludes their two day meeting with an announcement at 2 pm that interest rates will not change today. That’s what the markets are expecting. There has been all kinds of hot air coming from several Fed officials that rates need to rise now, but Chair Janet Yellen has been on the other side, sticking with her more accommodative stance. It would be very hard to believe that the majority of voting members would overtly vote against their chair.

The statement comes next and because it’s not one of the quarterly press conference meetings, it’s even further unlikely that Yellen & Co. will raise rates without releasing their updated forecast and answer questions. Regarding the verbiage, there is no consensus on what will be released.

Looking at the calendar, the most likely opportunities for the Fed to raise interest rates are at the June and December meetings which include the quarterly update. I took September off the table because it’s too close to the election and without a clear and present crisis to fight, it’s unlikely the Fed would move so close to election day.

My own stance remains unchanged since 2008. That is that the Fed should not raise rates at all until the other side of the next recession. I wasn’t referring to getting through the Great Recession. I meant the mild one that should come next this decade. After that recession, I believe interest rates will go on a 25-40 year bull market with inflation finally becoming commonplace again.

That forecast also coincides with the final crisis in Europe later this decade. One way or another, with or without the Euro, Europe’s rubber meets the road this decade. Kicking can is no longer possible. There will likely be defaults and reorganizations, but Europe should become a great place to invest in the 2020s.

Yellen & Co. Set a Precedent
Getting back to the subject line of this update, I firmly believe that the Fed’s main reason for not raising rates isn’t all that transparent. However, the “secret” I call it isn’t nefarious or with some conspiracy laden ulterior motive.

Yellen is in a tough spot. The U.S. economy is certainly strong enough to withstand a rate hike or two. It’s hard to argue that although the Fed did set all kinds of precedents in December with that increase.

  • First rate hike ever with inflation under 1%.
  • First rate hike ever with the annual social security COLA at 0%.
  • First rate hike ever with wage growth needing to jump 100% to hit the Fed’s target.
  • First rate hike ever with industrial production on the verge of recessionary levels.
  • First¬†rate hike ever with GDP barely 2%.
  • First rate hike ever with inflation expectations close to 0%.
  • First rate hike ever with retail sales closer to recession than escape velocity.
  • First rate hike ever with non-farm payroll job growth continuing to decelerate.
The “Secret”
Anyway, if Yellen & Co. hike rates now or soon given what’s going on in Europe and Japan with negative interest rates, the Euro and Yen would likely fall precipitously, meaning that the U.S. dollar would strengthen dramatically. This would almost certainly lead to an enormous flight of capital out of Europe and Japan and into the U.S. Remember, capital always flows to where its treated best.

Before the financial markets were truly global, you can see how this occurred in the early to mid 1980s as the dollar soared to its highest levels of all-time. Massive capital inflows would first go into the dollar and then typically into shorter-term treasury instruments. In the 1980s, we also saw flows into large cap, blue chip stocks, which I can see happening this decade and fueling the Dow into the 20,000s.

In the 1980s, these capital inflows helped fuel the nearly vertical rise in our stock market. However, eventually, when there are enormous capital flows to one system and out of others, market dislocations grow and grow and grow. Look at how sharply the dollar began to collapse from 1985 to late 1987.

When newly appointed Fed chair, Alan Greenspan, raised rates in August 1987, the dollar still fell as stocks peaked. As the stock market began to unravel in mid-October, then Treasury Secretary, James Baker, famously warned on the morning of the October 19th crash that the U.S. was not going to intervene and support the dollar. With portfolio insurance to add fuel to the fire, our stock market crashed.

I believe the Fed fears a much worse inflow of capital into this country which may be good in the short-term, but disastrous long-term. There is much more global capital today and our financial system is much more linked than ever. Money can flow around at warp speed.

Should we see a torrent of capital flow into the U.S., these kinds of events rarely, if ever, end well. See Japan since 1990 as one piece of evidence. Should our dollar resume its secular bull market, which I think it will by 2017, we may be looking at a major global financial market dislocation later this decade as a result, something the Fed doesn’t want to contribute to.

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Apple & The Fed. A Volatile Concoction…

The FOMC begins their regularly scheduled two-day meeting today. Typically, stocks are quiet with a small upward bias. However, Apple reports earnings after the bell and that almost always provides some movement as the tech behemoth has an outsized weighting in the S&P 500, Dow and NASDAQ 100. I have absolutely no opinion on how their earnings will be and I really only care about how the market reacts anyway. The fact that it has sold off into earnings gives the bulls a slight edge to reverse the weakness by the end of the week.

Getting back to the Fed, expectations are that rates will remain as is for now with June as a less than 50% of a hike. September should be off the table as it is an election year and there is no clear and present danger to fight. So that really means that if Yellen & Co. do not hike rates in June, December is the next viable option. What a far cry from four rate hikes in 2016 as first forecast by the Fed!

Regarding the stock market, I remain in the cautious camp since last week as I believe the major indices are in the process of peaking. Apple will have a lot to do with the short-term direction of the NDX which is underperforming. None of the four key sectors are rolling over which is one reason I believe we will just see a modest pullback. Previous defensive leaders, staples, utilities and REITs are all bouncing back, but it looks like they have seen their peaks for a while and strength should be sold.

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