A Critical Week for Markets

What’s in Today’s Report:

  • A Critical Week for Markets
  • Weekly Economic Cheatsheet:  CPI on Wednesday is the key report.
  • Weekly Market Preview:  Can a soft CPI report continue to support markets?

Futures are slightly higher thanks to solid Chinese economic data and following a mostly quiet weekend.

Chinese exports rose more than expected (18% vs. (E) 14.1%) and that’s helping to slightly improve global economic sentiment.

Politically, Senate Democrats passed the Inflation Reduction Act over the weekend as expected and it should become law this week. But, markets don’t expect any meaningful impact on corporate earnings in the n

Today there are no notable economic reports and most of the focus will be on the specific implications of the Inflation Reduction Act, which should pass the House this week.  But, this bill does not appear to have any meaningful macro-economic implications.  So, markets will look ahead to Wednesday’s all-important CPI report, and with stocks still extended, it needs to be better than expectations to support the rally.

Momentum Indicator Update, July 11, 2017

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About two months ago, as markets were grinding relentlessly higher despite underwhelming economic fundamentals, I identified four momentum indicators that would tell us when this market was losing momentum and when the chances for a pullback were rising.

Those four indicators were: 1) Consumer sentiment, 2) NYSE Advance/Decline line, 3) Semiconductors (SOXX) and 4) Super-cap internet (FDN).

Over the subsequent eight weeks, three of those four indicators have remained broadly positive. Only semiconductors have lost momentum (SOXX hit multi-month lows in Thursday’s selling). But while the three remaining momentum indicators are still giving positive signals, recently there have been some signs of fatigue.

First, FDN (First Trust DJ Internet Index Fund) held the June lows, but it’s stuck in a range currently and can’t seem to break to a higher high.

Second, the NYSE Advance/Decline line is sitting on an uptrend in place since late-February 2016, and if we get any sort of a nasty sell-off in the next few days (like we saw last Thursday) that trendline could break.

Finally, looking at consumer sentiment, unending skepticism towards this now eight-year-long rally remains its most consistent fuel; however, that may finally be changing.

Retail investor sentiment indicators remain overly cautious. The American Association of Individual Investors Bulls/Bears Sentiment is cautious, as there is just 29.6% bulls vs. a historical 38.5%. But, in a notable change, the number of bears also is below average (29.9% vs. the average of 30.5%).

The difference is made up in the “Neutral” category, which has surged to 40.6% vs. an average of 30.5%. Now, that’s not overtly bullish, but it anecdotally reflects the idea that you simply “must” be invested as they market grinds higher. And, that idea is in line with a recent similar reading from institutional investors.

Yesterday, I read a survey from Citi that showed institutional investors are holding their lowest levels of cash since before the financial crisis! According to survey respondents, in June the median cash holdings for institutional investors was just 2.5%, down sharply from the 7.5% level at the end of September 2016. That’s the lowest level of cash on hand since before the financial crisis.

The results from a Citi survey of institutional investors show that cash holdings by institutional investors are at the lowest level since before the financial crisis..png

Now, one statistic doesn’t mean an impending market pullback, but this survey data does generally correspond to the idea that the TINA trade (There is No Alternative to stocks) has finally, and begrudgingly, pulled the remainder of cash off the sidelines and into the market.

And, as history has taught us, we can all guess what happens next.

Regardless, the major point I’m trying to make here is this: We’re nearing a pretty substantial tipping point in markets, and while both the bulls and bears have points of evidence on their side, the benefit of the doubt remains, for now, with the bulls. Still, we need a continuation of the recent better economic data and better inflation numbers to power this market higher, otherwise the chances of some sort of a pullback will indeed rise.

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Three Momentum Indicators to Watch, June 6, 2017

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In Monday’s Sevens Report, we talked about how momentum, more so than anything else, is driving this rally in stocks. And while momentum is clearly a powerful force, it can also be fickle. When momentum dissipates, there are usually air pockets underneath the market (see August 2015).

The trick to outperforming, then, is knowing when momentum is waning, and we want to identify three momentum indicators we’re watching to stay ahead of that move. Those momentum indicators are: Two tech sub-sectors (FDN and SOXX), the NYSE Advance/ Decline Line, and Market Sentiment.

Momentum Indicator #1: Sentiment Indicators.

Starting with the latter, it’s important to realize that momentum and sentiment, while related, are different. Momentum refers to a state of market psychology where higher prices themselves become the biggest bullish force, as underinvested people and portfolio managers chase stocks higher and aggressively buy any dip out of fear of underperforming. Unlike sentiment, strong momentum is not, by itself, a contrarian indicator (like overly bullish or bearish sentiment indicators).

That said, in today’s market, a very bullish sentiment indicator could be a sign of an impending loss of momentum, as the bullish reading implies that everyone is “all in” on stocks, leaving a lack of capital on the sidelines that can “chase” stocks higher.

Right now, despite new highs in stocks, there are few signs that sentiment is near the highs. In fact, sentiment remains remarkably depressed for how strong the market has been in 2017.

The AAII Investors Sentiment Survey showed just 26.9% bulls vs. the historical average of 38.5%. The TMI Group Market Sentiment Index revealed just 49.8% bulls (the scale goes to 100) while the Citi Panic/Euphoria Model remains comfortably in “Neutral” range.

Point being, if bullish sentiment is a sign of an impending loss of momentum in stocks, we’ve got a long way to go.

Momentum Indicator #2: FDN & SOXX.

One of the reasons I look at sector trading every single day is because every rally is driven by a few sectors, or what I and others call “leadership” sectors. When these leadership sectors falter, that usually implies an impending loss of momentum.

Since late 2016, semiconductors have been the biggest leadership sector in the markets. They rallied big during the Q4 ’16 rally, and they are up big so far in 2017 (SOXX up 22%). While other sector leadership shifted from late ’16 to ’17 (banks and small caps to utilities, consumer staples and super-cap internet) semiconductors have continued to scream higher.

Similarly, as I and others have noted, nearly half of the 2017 S&P 500 rally can be attributed to just a few stocks: AAPL, AMZN, MSFT, FB, GOOGL. Those stocks are heavily weighted in the super-cap internet ETF FDN, and as such, that is also a leadership sector in 2017.

So, these are two important sectors to watch as any possible breakdown will imply a loss of momentum. It happened in the spring of ’14 when the then leadership sector biotech broke down and caused a pullback. It also happened before the pullback in August ’15 when the “FANG” stocks (leaders at the time) topped out in July— a month before the stock market fell.

Right now, the uptrends in FDN and SOXX are in good shape, but we will be looking for a violation of those uptrends as a clue the market may be about to lose momentum.

Momentum Indicator #3: NYSE Advance/Decline Line.

I’m not a huge fan of multiple measures of market breadth, but I do watch the advance/decline line, as it gives insight into buyer enthusiasm (i.e. the level of momentum). And, it has been an accurate leading indicator in these types of markets (the A/D Line topped out in April 2015, a month before the market topped in May).

Right now, the A/D line just hit a new high. But, once again, we’re looking for any signs of a trend break as a sign that momentum is waning.

Bottom Line

You’ll never hear me say that fundamentals don’t matter, because they do over the medium/longer term, and that’s what most of us are focused on. Yet we’re also judged in the short term by our clients and our competition, so getting both right is important.

Momentum in stocks remains higher still, but getting the break right, before our competition, will be the key to outperforming. With stocks this extended, a sharp, nasty and painful pullback is lurking somewhere out there. We’re focused on making sure you avoid it, and we’ll update you when any of these momentum indicators begin to break down.

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Volatility—What Goes Down Must Come Up, But It Can Take a Long Time!, May 10, 2017

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Historically low volatility is becoming a bigger topic in the markets these days, and while earlier in the year low volatility was referenced with more of an observational tone, recently I’ve been hearing the bears touting low volatility as something that simply must revert soon, and as such we should be cautious on markets.

VIX volatility - What goes up must come downI don’t have a crystal ball, so I don’t know when normal volatility will return. However, I do want to spend a few moments pushing back on the idea that low volatility by itself means a correction is coming (obviously volatility will return, but as usual the key question is “when,” and ultra-low volatility doesn’t always mean it’ll return to normal levels soon).

First, you’re not seeing things. Volatility is at multi-decade lows, and that can be seen in multiple ways. First, the VIX hit a 23-year low yesterday, falling to the lowest level since 1993.

Second, so far in 2017 the S&P 500 has moved more than 1% on just three separate days, all of which were in March. By this time of year we’ve normally had 19 days where the S&P 500 has moved more than 1%.

Third, with a close at 9.98 yesterday, the VIX now is lower than nearly 99.5% of all the closes since Jan. 1, 1990. Put another way, it’s only closed this low about 0.05% of the time during the last 27-plus years. So, the VIX is extraordinarily low.

But, that doesn’t mean it’s going to bounce back soon.

First, According to a note from ConvergeEx, the all-time low for the VIX 50-day moving average is 10.8, which it hit in Feb. 2007. Right now, the 50-day moving average for the VIX is 12.17.

Takeaway: It’s very unlikely that the VIX will stay at these ultra-low levels for very long, but that doesn’t mean a big rally is looming. It would take several more weeks of VIX at these levels to drag the 50-day MA down towards the all-time lows.

Second, looking at the VIX to measure volatility can cre-ate a bit of an odd picture, because again the VIX is based on options prices and not the actual price move-ments of the S&P 500. Looking at actual stock price movement, it confirms what our eyes tell us.

Going back to the 1950s, the current volatility of stock prices is 48% of its longer-term average. That’s really low. And, this period of historically low volatility has been going on for 78 days (including yesterday). But, that doesn’t mean it necessarily will bounce back.

First, there have been two specific periods of similarly low volatility in the last 20 years. First in mid-2014 (75 days) and second from Nov. ’06 to March ’07 (79 days).

Second, we’re not even close to the record for low volatility. In 1992/1993 and 1995/1996 we saw respective periods of ultra-low volatility last for 179 and 254 days, respectively. That’s double and triple what we’ve seen so far in 2017.

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