Bulls Try To Survive Employment Report
If there is one economic report that captures the interest of Wall Street, it is the monthly employment situation report released on the first Friday of every month at 8:30 a.m. EST. The early reaction in the futures market was favorable, but that must carry into Friday’s close to be meaningful. From MarketWatch:
The U.S. economy generated 175,000 jobs in February despite harsh winter weather, but the unemployment rate ticked up for the first time in 14 months, the government reported Friday. The steady pace of hiring last month — it was the biggest increase in three months — suggests the economy has not slowed as much as a recent spate of indicators appear to indicate. The unemployment rate, for example, edged up because more people entered the labor force in search of jobs. That’s usually a sign that workers think more jobs are available. Yet economists say it may take another month or two to get a good read on the economy’s health because of unusually cold and snowy weather in the early part of 2014.
How Concerned Are The Markets?
We could list numerous concerns for stock investors, but the bullets below capture the big three:
From an economic perspective, market participants tend to vote with their investments. When concerns about future economic outcomes increase, investors tend to gravitate toward more conservative sectors, such as consumer staples. Below is a comparison of the current demand for defensive consumer staples relative to the S&P 500 during a crisis in 2011. In 2011, the stock market plunged in August following a credit downgrade of U.S. debt. Demand for consumer staples starting increasing well before the stock market’s waterfall decline.
If we use 2011 as the bearish proxy, the present day demand for defensive consumer staples relative to the S&P 500 tells us investors are much more confident in 2014 than they were in 2011.
Putin Keeps Ukraine On Market’s Radar
Markets have an almost infinite number of moving parts. While Wall Street turned its attention to Friday’s economic data, the tension in Ukraine continues. From Reuters:
President Vladimir Putin rebuffed a warning from U.S. President Barack Obama over Moscow’s military intervention in Crimea, saying on Friday that Russia could not ignore calls for help from Russian speakers in Ukraine. After an hour-long telephone call, Putin said in a statement that Moscow and Washington were still far apart on the situation in the former Soviet republic, where he said the new authorities had taken “absolutely illegitimate decisions on the eastern, southeastern and Crimea regions. “Russia cannot ignore calls for help and it acts accordingly, in full compliance with international law,” Putin said.
Consumer Stocks Worth Watching
When investors are confident about future economic outcomes, they tend to prefer growth-oriented consumer stocks over defensive-oriented consumer staples stocks. During the early 2014 pullback in stocks, investors shunned this sector. From Bloomberg:
Investors are having a change of heart about U.S. consumer stocks, a sign their optimism about Americans’ discretionary spending remains intact even after a January selloff. The rebound has been swift, showing that some investors overreacted to bad winter weather, sluggish holiday sales and negative earnings pre-announcements from several fund members, said Timothy Ghriskey, chief investment officer at Solaris Asset Management LLC in New York, which manages about $1.5 billion in assets. The shift has been driven by “some nice, positive surprises” on quarterly results from companies — including Gap Inc. (GPS) and Macy’s Inc. (M) — and a recognition that income growth and hiring, the drivers of U.S. consumption, haven’t deteriorated, he said.
The chart below is a snapshot of consumer stocks (XLY) relative to the S&P 500 taken during Friday’s trading session. The recent improvement in investor demand can be seen on the right side of the chart. Stock market bulls want the current look to morph into a new high. Until a new high is made on the chart below, we will continue to pay attention with an open mind.
Investment Implications – A Perfect Bullish Storm?
Prior to the release of Friday’s employment data, we presented the chart below as bullish evidence from an economic and investor conviction perspective.
Thursday’s article shows the same ratio above as of October 2007 when bearish economic conviction began to noticeably overtake bullish economic conviction. The moral of the story is 2014 looks much better than late 2007.
With over 20 years experience on Wall Street, we can state confidently that getting too excited one way or another about the initial reaction to a monthly labor report is not wise. The “perfect storm” scenario for the stock market bulls is outlined below by Andrew Wilkinson, chief market analyst at Interactive Brokers. From The Wall Street Journal:
“The February jobs report is something of a perfect storm for the U.S. economy and is likely to further fuel bullish fervor across the stock market. At the same time the bond market can dwell upon a lift in the rate of unemployment and the still stable outlook for inflation to fight off accusations that the Federal Reserve will soon be tightening policy. The latest strength in the stock market appears to have been driven by hopes that what the winter took away, the spring will reclaim in terms of a jobs rebound. Today’s employment report compounds such expectations.”
The evidence in hand supports the risk-on case. However, history tells us periods of rising interest rates can be difficult to navigate. The Fed is always a factor.
If the bulls can nail down a green close for stocks Friday, we are prepared to make two chess moves from an allocation perspective: (1) reduce exposure to an already small stake in bonds (TLT), and (2) incrementally increase exposure to stocks (SPY). Where that incremental exposure comes from is yet to be determined, but some candidates include large cap growth (IVW), and cyclical stocks (XLY). If we see a red close Friday, we might rethink the bond reduction, as well as the stock addition. We have the plans in place; the market will decide on the direction of our next portfolio tweak.
Fed’s Fisher Down On QE
The Federal Reserve has signaled to the markets that economic data would have to veer significantly off their anticipated path to terminate the Fed’s tapering process. Some additional taper-friendly remarks were made this week. From Reuters:
A U.S. Federal Reserve policymaker who has long criticized its bond-buying stimulus said on Wednesday the program has lasted too long, and there are signs it is now distorting financial markets and encouraging risk-taking. In a speech in Mexico City, Dallas Fed President Richard Fisher amplified some lingering concerns that the central bank’s policy stimulus is stoking asset-price bubbles that “may result in tears” for investors acting on bad incentives. “There are increasing signs quantitative easing has overstayed its welcome: Market distortions and acting on bad incentives are becoming more pervasive,” he said of the asset purchases, which are sometimes called QE. “I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis,” he said in prepared remarks to the Association of Mexican Banks.
2007: Would I Rather Be Long Or Short Stocks?
The weekly chart below shows the performance of longs (SPY) relative to shorts (SH). When the ratio rises, we would “rather be long” and when the ratio falls, the short side of the market is outperforming the long side. The weekly chart helps us stay with the dominant trend by filtering out some distracting day-to-day volatility present on a daily chart. The red and blue lines are moving averages which filter out some of the week-to-week volatility, allowing us to focus on the dominant weekly trend. Was the long vs. short chart helpful in 2007 when the stock market peaked? Yes, the chart took on an “I’d rather be short look” in October 2007 with the S&P still trading above 1,500. The S&P 500 did not find a bottom until reaching 666 in March 2009.
2014: What Is The Ratio Telling Us Now?
The chart continues to maintain an ‘I’d rather be long stocks” look: (a) price is above the red and blue moving averages, and (b) the slopes of the red and blue moving averages are positive.
Investment Implications - The Evidence In Hand Is Bullish
Since bullish utopia never exists in the financial markets, our market model makes allocation decisions based on the weight of the evidence. The weight of the evidence aligns with the current bullish look of the long vs. short ratio. Consequently, we continue to hold U.S. stocks (SPY) and technology stocks (QQQ) as core portfolio positions. Unless the reaction to Friday’s employment report brings buying support for bonds, we will consider reducing our already small exposure to Treasuries (TLT) Friday. The market’s reaction to the employment report is more important than the report itself. In the first four trading days of the five day week, the S&P 500 tacked on 17 points. Over the same period, the Aggregate Bond ETF (AGG) dropped 0.28%, telling us the demand for defensive assets continues to lag the demand for growth assets; that needs to change before the stock bears make any significant progress.
A Small Step For Ukraine
While market fear related to Ukraine has subsided a bit, it is still prudent to keep an eye on Mr. Putin. The House voted on Ukrainian aid this week. From MarketWatch:
The House of Representatives on Thursday easily approved legislation that would extend financial aid to Ukraine. The bill allows Ukraine up to $1 billion in loan guarantees, which the bill’s sponsors say cover the risk of losses if Ukraine defaults. The vote was 385-23. Both chambers of Congress would need to approve the loan guarantees and the Senate is still working on its bill.
Markets Love Central Bank Action
Anyone who follows the markets knows that action from central banks tends to impact risk-related behavior, often in a significant manner. With the European Central Bank (ECB) meeting Thursday, the International Monetary Fund (IMF) is calling for a more proactive monetary policy stance from the ECB. A March 4 post on IMF Direct made the following statements regarding inflation and ECB policy:
- Ultra low inflation—let us call it “lowflation”—can be problematic for the euro area as a whole and for financially stressed countries, where it implies higher real debt stocks and real interest rates, less relative price adjustment, and greater unemployment.
- Along with Japan’s experience, which saw deflation worm itself into the system, this argues for a more pre-emptive approach by the ECB.
The conclusions and recommendations in the IMF post are below:
You can have too much of a good thing, including low inflation. Very low inflation may benefit important segments of the population, notably net savers. But in the current context of widespread indebtedness problems, it is working to the detriment of recovery in the euro area, especially in the more fragile countries, where it is thwarting efforts to reduce debt, regain competitiveness and tackle unemployment. The ECB must be sure that policies are equal to the tasks of reversing the downward drift in inflation and forestalling the risk of a slide into deflation. It should thus consider further cuts in the policy rate and, more importantly, look for ways to substantially increase its balance sheet, be it through targeted LTROs or quantitative easing (public and private asset purchases).
Evidence Has Continued To Improve
Regular readers know our thoroughly backtested approach to investing is based on staying aligned with hard evidence rather than investing based on forecasting or personal opinions. The chart below was originally presented in a February 7 article entitled Improving Profile More Favorable For Stocks. Since the chart was provided as bullish evidence, the S&P 500 has tacked on 76 points.
How Does The Same Chart Look Now?
The answer to the question above is “even better from a probability perspective”. The S&P 500 has recaptured all the moving averages, cleared the previous closing high (see blue line), and the slopes of the moving averages have turned up, which indicates improving bullish conviction from investors.
Fed Has To See Weak Employment Data
The Fed has made it clear the hurdle to alter their tapering schedule is high. However, they cannot deny the recent weakness in employment-related data. The weak trend continued Wednesday. From The Wall Street Journal:
U.S. businesses added jobs at a very modest pace last month as factories added few new employees, according to a survey of private-sector hiring released Wednesday. Despite the tepid results—and a large downward revision to January’s numbers—the data won’t likely move analysts to change their forecast for the Friday’s widely-watched U.S. employment report from the Labor Department. Tuesday’s report said private-sector payrolls in the U.S. increased by 139,000 jobs in February, according to payroll processor Automatic Data Processing Inc. ADP -1.06% (ADP) and forecasting firm Moody’s Analytics. That was below the consensus estimate of 160,000 new jobs predicted by economists surveyed by The Wall Street Journal. ADP also cut January’s increase to 127,000 jobs from 175,000.
Investment Implications – Have Been And Still Are Long Stocks
During Monday’s sell-off in stocks sparked by Mr. Putin, we wrote:
It is important that we remain flexible and make decisions based on hard evidence, rather than fear.
The same concept of making decisions based on hard evidence can be applied to all situations, bullish or bearish. Are the moving averages in the charts above a foolproof way to manage risk? No, which is why our market model uses numerous inputs from multiple time frames. However, the moving averages do add value and also do an excellent job of conveying the basic concepts. How did the same chart look before the August 2011 sell-off in equities?
The evidence in hand continues to support holding our core positions in U.S. stocks (SPY) and technology stocks (QQQ). We have also established some smaller positions in U.S. large cap growth stocks (IVW), and gold miners (GDX). If the smaller stakes can earn their keep, we may increase our exposure to them. On the more defensive side, the market will determine how we manage our relatively small stake in bonds (TLT).
Ukraine Fears Ease
Monday and Tuesday have been about the conflict in Ukraine. Monday’s news was fear related; Tuesday’s news was better. From Bloomberg:
U.S. stocks rose, with the Standard & Poor’s 500 Index rebounding to a record from its biggest loss in a month, as comments from Russian President Vladimir Putin signaled the Ukraine crisis won’t immediately escalate. “On a very short-term basis, everything you’ve seen in the market has everything to do with the Ukraine,” Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees about $160 billion, said by phone. “But over last 2 weeks, the market has moved higher with the exception of yesterday. The bet has been made that the economy continues to expand and most of the disruption we’ve seen has been from the weather.”
Leadership Speaks To Economic Confidence
As we explained using a 2008 example in this recent video clip, during bear markets or risk-off periods investors tend to gravitate toward defensive assets, such as bonds (AGG), and away from growth-oriented assets, such as stocks (SPY). The observable evidence, as of Tuesday, continues to side with the bullish case for stocks and the economy.
Budget Proposal From President
With mid-terms looming in the fall, those facing re-election typically shy away from controversial programs, meaning the term “non-starter” may apply to much of President Obama’s budget. From The Wall Street Journal:
President Barack Obama proposed a $3.9 trillion budget package Tuesday peppered with new taxes on upper-income Americans and businesses, plus numerous spending initiatives aimed at bolstering education, research and low-income work programs. Many of the proposals are likely to meet a cool reception on Capitol Hill, where both parties are preparing for November elections that could change the balance of power on Capitol Hill.
Investment Implications – No Core Changes Monday or Tuesday
Based on our market model’s read of the evidence, we have increased exposure on the growth side of our portfolios six times since the market’s risk-reward profile began to improve on February 7. Monday’s sell-off did not inflict any significant damage, and thus we held our long positions in U.S. stocks (SPY) and technology stocks (QQQ). If stock bulls can carry Tuesday’s momentum forward, we may cut back on our bond exposure (TLT) later this week.
Our short list of investment candidates have an undoubtedly risk-on bias: large-caps (SCHB), technology (XLK), large cap growth (IVW), mid-caps (MDY), small cap growth (IWO), and health care (XLV).
Using Hard Evidence As A Guide
While risk-on periods always battle countertrend rallies, making decisions based on the weight of the evidence will typically keep you aligned with the markets. The market has been giving “the weight of the evidence remains bullish” clues for several weeks. The S&P 500 made a new closing high Tuesday, which means the evidence has been a generous guide. The following articles provide examples of using hard evidence to make allocation decisions:
Ultimatum Reported By Reuters via Telegraph
The following information was posted on telegraph.co.uk this morning:
There are a lot of moving parts to any geopolitical crisis, and thus, things can change quickly and dramatically. Therefore, it is important that we remain flexible and make decisions based on hard evidence, rather than fear.
ECB Has Key Meeting This Week
While the events in Ukraine will grab most of the headlines this week, the ECB has a get-together scheduled. As we outlined on December 4, central bankers are terrified of deflation. From MarketWatch:
A prolonged period of low inflation in the euro zone may derail the currency area’s fragile economic recovery and must be fought with additional monetary stimulus, International Monetary Fund chief Christine Lagarde said Monday. Lagarde, who was speaking at a conference in Bilbao, northern Spain, said that while the European Central Bank already has taken a number of strong measures to help the euro area, “even further accommodative policies and targeted measures are needed to address low, below-target inflation and achieve lasting growth and jobs.” Annual inflation in the euro zone was 0.8% in February, according to European statistics office Eurostat, well below the ECB’s target of just below 2%. The ECB will meet Thursday to decide on interest rates for the area.
Buffet: Best Days Lie Ahead
While it is nearly impossible for individual investors to gather scuttlebutt in the same manner Warren Buffet does, the markets understandably take note when the Oracle of Omaha offers his opinion on the state of the economy. From MarketWatch:
Though we invest abroad as well, the mother lode of opportunity resides in America,” Mr. Buffett wrote in his annual letter to shareholders, released Saturday along with Berkshire’s fourth-quarter and annual report. The “dynamism embedded in our market economy will continue to work its magic,” Buffett wrote. “America’s best days lie ahead.”
Investment Implications – Watching Geopolitical Developments
As regular readers know, our personal opinion regarding the conflict in Ukraine is of little value from an investment perspective. However, the aggregate response to geopolitical developments this week is very important. The tweet below sums up our approach:
Our market model relies heavily on weekly outcomes. Therefore, the look of weekly charts on Monday is not nearly as significant as how they look on Thursday or Friday. Our rules do allow for incremental allocation adjustments during the week, which means we are open to reducing risk if the observable evidence calls for it. The glass half empty Monday is our U.S. stocks (SPY) and technology stocks (QQQ) were having a difficult session. The glass half full perspective looks at gains in our bonds (TLT) and gold-related position (GDX). TLT was up 0.67% midday and GDX had tacked on 2.47%. The S&P 500 chart below shows some areas where buyers may become interested if the situation in Ukraine continues to spook the markets.
As covered in detail March 1, the weight of the evidence continued to support the bullish case as of the close on Friday, February 28. Just as we needed to see hard evidence of a bearish turn before overreacting to the 1929 parallel, it is important that we stick to our discipline during times of increasing fear and uncertainty. If the Ukrainian situation flips the markets to a risk-off stance, observable shifts will begin to appear.
The Bears Had A Nice Set-Up
In late January/early February, economic fundamentals were looking shaky. The text below comes from a February 3 Reuters article:
U.S. manufacturing activity slowed sharply in January on the back of the biggest drop in new orders in 33 years while construction spending barely rose in December, pointing to some loss of steam in the economy. “The disappointing data provide further confirmation of a dramatic slowing in economic growth momentum,” said Millan Mulraine, deputy chief economist at TD Securities in New York. The Institute for Supply Management (ISM) said its index of national factory activity fell to 51.3 last month, its lowest level since May 2013, from 56.5 in December.
The negative data spilled over from the fundamentals into the technicals. The chart of the S&P 500 below shows a vulnerable stock market on Monday, February 3.
Observable Evidence Said Buy On February 7
Regular readers know our thoroughly backtested approach to the markets is based on staying aligned with hard evidence, rather than investing based on forecasting or personal opinions. Despite all the bearish sentiment born from the weak economic data, the evidence started to improve on February 7 prompting this “buy” tweet below:
Then Came That Scary 1929 Parallel Chart
With investors already spooked by the recent slide in economic reports, the bears picked up some ammunition when the chart below started making the rounds on Wall Street. The text below comes from a February 11 MarketWatch article:
There are eerie parallels between the stock market’s recent behavior and how it behaved right before the 1929 crash. That, at least, is the conclusion reached by a frightening chart that has been making the rounds on Wall Street. The chart superimposes the market’s recent performance on top of a plot of its gyrations in 1928 and 1929. The picture isn’t pretty. And it’s not as easy as you might think to wriggle out from underneath the bearish significance of this chart.
The chart above is a form of forecasting. The forecast created fear. Forecasting brings bias. In this case, the 1929 forecast created a bearish bias for many investors. What did the evidence say to do on February 11, the day the 1929 chart appeared on MarketWatch? The evidence said “take a second incremental step to increase exposure to stocks.” The time stamped tweet below was based on facts in hand, rather than bias, fear, or a bearish 1929 forecast.
Were we aware of the 1929 parallel when we added to our stock exposure on February 7 and 11? Yes, in fact we wrote about the 1929 chart in a February 11 article.
In Face Of Fear, February Was Best Month Since July
If we fast forward to Friday, February 28, Bloomberg told us the improving evidence in early February was followed by an impressive month for stocks, bonds, and commodities:
For all the talk of a crisis at the start of the month, February ended up being the best period for global markets since July. Stocks, bonds and commodities rose together in February for the first time in seven months, reversing January’s losses in equities and raw materials. The Standard & Poor’s 500 Index has closed at a record for two straight days, erasing losses from January spurred by concern economic turmoil would spread from emerging markets as the Federal Reserve began reducing stimulus efforts.
How Does The Evidence Look Now?
Markets are driven by fundamentals, or more specifically asset prices are set by the aggregate and net interpretation of the all the fundamental data. If the aggregate opinion is favorable, stocks tend to rise. If the aggregate opinion is unfavorable, stocks tend to drop. Charts allow us to monitor the aggregate interpretation of the fundamentals. What are the charts saying now? To answer that question, this week’s video looks at the S&P 500 (SPY), NASDAQ (QQQ), small caps (IWM), consumer staples (XLP), consumer discretionary stocks (XLY), high beta (SPHB), emerging markets (EEM), warnings from 2008, and a significant development on the long-term chart of the broad NYSE Composite Stock Index.
Are There Reasons To Be Concerned?
Yes, there are always reasons to be concerned. There is no such thing as an “all clear” time to invest in stocks. If you are waiting for the perfect time to buy stocks, you will be waiting for the rest of your life. We outlined some potentially bearish reasons to pay attention with an open and flexible mind on February 20. We can add Ukraine to the list. From Friday’s The Wall Street Journal:
Traders blamed the late-day reversal in sentiment on news reports indicating intensifying tensions in Ukraine, whose government collapsed nearly a week ago following weeks of protests in Kiev. News agencies reported an incursion of Russian military forces in the Ukrainian region of Crimea. U.S. officials said they were closely watching the latest developments. “You see headlines like that, and you get a little spooked,” especially ahead of a weekend, said Sal Arnuk, co-head of equity trading at brokerage firm Themis Trading. But Mr. Arnuk played down the potential for any conflict in Ukraine to affect financial markets. “If anything, it’s an overreaction,” he said.
Investment Implications - The Charts Don’t Lie
If slow growth, rising inflation, or tensions in Ukraine are to derail stocks, which they may, then we know with 100% certainty the concerns will eventually show up as observable and bearish shifts on the chart of the S&P 500. That bearish shift could start Monday, but it has not occurred yet. On February 27, we noted the bullish significance of the S&P 500 printing a new all-time closing high. We can add a new all-time weekly closing high to the list.
When we look at the chart above, it helps us understand the concept of “the market does not care what you think”. The expression is harsh, but our personal opinions have little impact on asset prices. What matters is what the market thinks, or the aggregate opinion of future economic outcomes. When the market gets concerned/bearish, then we should be concerned as well since the odds of investment success will become less favorable.
The evidence in hand calls for an allocation heavily slanted toward “risk-on”. Consequently, we own U.S. stocks (SPY), and technology stocks (QQQ). Given the improvement seen over the last five trading sessions, we added to our stock exposure Friday for the sixth time since making the first incremental buy on February 7. When the evidence shifts, our rules-based system will call for an incremental reduction in equity exposure. When will that happen? You will have to ask the millions of people around the globe that make up the aggregate opinion driving asset prices, or you could follow the charts with an open, flexible, and unbiased mind.
Simple Support And Resistance
Thursday’s new all-time closing high on the S&P 500 is relevant from a support and resistance perspective. The previous all-time closing high of 1,848 was printed January 15.
Between January 15 and February 26 the S&P 500 was unable to surpass 1,848 on a closing basis, which established 1,848 as resistance. From stockcharts.com:
Support and resistance represent key junctures where the forces of supply and demand meet. Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance. Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices.
The expression “what once was resistance now becomes support” tells us 1,848 could now establish itself as a level where buyers are more likely to step in. The S&P 500 closed at 1,854 Thursday.
Could Weak Data Bring A Taper Pause?
Since the Federal Reserve does not have a formal meeting scheduled until March 18, the market’s perception of what the Fed may do, right, wrong, or indifferent, is what is important over the next three weeks. Thursday’s report on employment may increase the perception of a possible Fed pause relative to their tapering schedule. From Bloomberg:
More Americans than forecast filed applications for unemployment benefits last week, a sign the labor market is improving in fits and starts. Jobless claims increased by 14,000 to 348,000 in the week ended Feb. 22, exceeding all forecasts in a Bloomberg survey and the highest level in a month, from 334,000 in the prior period, a Labor Department report showed today in Washington. A Labor Department spokesman said no states were estimated and there was nothing unusual in the data.
Plunge Conditions No Longer Exist
We noted February 11 that it was not worth losing too much sleep over the 1929 stock market crash parallel unless the S&P 500 dropped below 1,737. The market’s lowest intraday level since then was 1,800, or nowhere near 1,737. Bloomberg provided some additional insight into the 1929 parallel this week:
After predicting the sell-off that began in January had the potential to snowball into a full-blown crash, Tom DeMark, the founder of DeMark Analytics LLC, is sounding the all-clear. DeMark said in a Feb. 5 interview on CNBC that the U.S. stock market had reached an “inflection point” and the S&P 500 could fall to 1,100 if certain conditions over the next few days were met. The price patterns he was watching for didn’t emerge, and by Feb. 6 DeMark knew the market wouldn’t plunge, he said in a Feb. 24 phone interview. The S&P 500 will probably rise to about 1,885 within the next three weeks after about six successively higher closes, DeMark said. That implies a gain of more than 2 percent. “It was just something novel to look at,” DeMark said of his earlier statement about the possibility of a crash. “The short-term requirements in early February had to exist, and they didn’t exist, and they expired.”
Investment Implications – Still Long, But Friday Is Big Day
As we noted February 26, hesitation in isolation is not bearish:
The hesitant nature of the markets has not morphed into a meaningful change in the demand for defensive assets relative to growth-oriented assets. Consequently, we continue to maintain exposure to U.S. stocks (SPY), and technology stocks (QQQ). The market’s recent hesitation near all-time highs is accounted for in our market model by maintaining exposure to bonds (TLT) and cash.
The comments above still apply; we made no allocation changes Thursday. However, the tweet below says Friday could set the tone for the week.
Should the market sell off after the slew of economic data Friday, the chart below highlights some levels below 1,848 that we will be keeping an eye on. The evidence in hand has, and continues to support, an allocation with a risk-on bias. Some buying above 1,850 would put that stance on even firmer footing.
Concerns Ease On Housing Front
Investors have been worried about slowing economic growth coupled with tapering from the Fed. While one report does not make a trend, Wednesday’s data on housing gave the stock market bulls a reason to remain optimistic. From The Wall Street Journal:
Sales of new homes surged unexpectedly in January, easing concerns about a deeper housing-sector slowdown. New single-family home sales rose 9.6% to a seasonally adjusted annual rate of 468,000 from a month earlier, reaching their highest level since July 2008, the Commerce Department said Wednesday. From a year ago, new-home sales were up 2.2%. Last month’s increase was boosted by sales in the Northeast, where activity expanded by 73.7% and reversed the prior month’s declines. The South and West also saw gains, but new home sales in the Midwest fell.
Cyclicals Trying To Make A Turn
Cyclical stocks (XLY) speak to more economically-sensitive businesses, such as Home Depot (HD), Ford (F), Nike (NKE), and Priceline (PCLN). Investors tend to favor cyclical stocks when they are confident about positive economic outcomes. As shown in the chart below, XLY has lagged the S&P 500 for most of 2014, but that trend is trying to turn back in the economic bulls’ favor. With reports on durable goods and GDP to be released before week’s end, the chart below needs a “subject to change” label. For now, the look is encouraging for the economy.
Glass Half Empty
One concerning trend in the housing market is the rate of foreclosures in densely populated New York and New Jersey, reminding us the aftermath of the financial crisis is still being felt. From Bloomberg:
The number of New York and New Jersey homeowners losing their houses reached a three-year high in 2013. Banks in these states have been slowly working through a backlog of delinquent loans that enabled borrowers to skip mortgage payments for years. Now these properties are poised to empty onto a market where affluent Manhattan suburbs neighbor blighted towns that are struggling most with surging defaults.
Investors Still Embracing Small Caps
Which company has a greater chance of going out of business: (a) the new restaurant that opened on the corner or (b) a well-established blue chip, such as Home Depot? The answer is obviously (a) the smaller restaurant. Investors understand the risks are higher in smaller companies. Therefore, when investors are concerned about future economic outcomes they tend to favor large caps over small caps. That is not what we have now. As shown in the chart below, the small cap growth ETF (IWO) is in greater demand than the large cap oriented S&P 500 Index.
While IWO is far from the best way to monitor stock market risk, common sense tells us full bore risk-off looks more like the 2008 version of the chart below.
1929 Revisited – Investment Implications
In Tuesday’s article, we provided an update on the scary 1929 parallel chart. The article made a clear distinction that the pattern was negated on the S&P 500. We did not say it had been negated on the Dow. However, the recent new high on the S&P 500 reduces the odds of the 1929 pattern playing out on any major U.S. index. The weight of the evidence in hand does not support an imminent 1929-style decline. For example, the vast majority of ETF leadership is in growth assets, rather than defensive assets. That may change starting as soon as today, but it has not changed yet. When the evidence shifts, we will not hesitate to make the necessary adjustments to our allocations. We have no bias either way. If we see another 1929, Flash Crash, or 1987 event again, the observable evidence will shift; something that has not happened yet. As of 3:00 p.m. EST Wednesday, the hesitant nature of the markets has not morphed into a meaningful change in the demand for defensive assets relative to growth-oriented assets. Consequently, we continue to maintain exposure to U.S. stocks (SPY), and technology stocks (QQQ). The market’s recent hesitation near all-time highs is accounted for in our market model by maintaining exposure to bonds (TLT) and cash.