Pay Attention To The Message The Yield Curve Is Sending

Do you love #volatility yet? Last week the market swung wildly back on forth on trade talks,tariff relief, inverted yield curves, and recession fears to finish the week on “hopes” banks will rescue the markets once again.

The bounce on Friday, was not unexpected as the market had gotten very oversold on a short-term basis. As shown in the chart below, the bounce off support gives the market a little room to the upside before several levels of resistance kick in. 

This oversold condition is why we took on a leveraged long position on the S&P 500 which we discussed with our RIAPRO subscribers on Thursday morning (30-Day Free Trial).:

“I added a 2x S&P 500 position to the Long-Short portfolio for an ‘oversold trade’ and a bounce into the end of the week. We will re-evaluate the holding tomorrow.”

We are holding the position over the weekend, as there is still room in the current advance for further gains. Also, given the President is fearful of a market decline, we expect there will be some announcement over the weekend on “trade relief” to support the markets.

However, this does NOT negate our commentary from last week suggesting this remains a sellable rally. To wit:

“The market is oversold on a short-term basis, and a rally from current support back to the 50-dma is quite likely.

Again, that rally should be used to reduce risk. I wrote about this on Tuesday in “5-Reasons To Be Bullish (Or Not) On Stocks:”

“For longer-term investors, it is worth considering the historical outcomes of the dynamics behind the financial markets currently. The is a huge difference between a short-term bullish prediction and longer-term bearish dynamics. As Howard Ruff once stated:

“It wasn’t raining when Noah built the ark.”

Notice that while the market has been rising since early 2018, the momentum indicators are negatively diverging. Historically, such divergences result in markedly lower asset prices. In the short-term, the market remains confined to a rising trend which is running along the 200-dma. At this juncture, the market has not violated any major support points and does currently warrant a drastically lower exposure to risk. However, the “sell signals” combined with negatively diverging indicators, suggest a “reduction” of risk, and hedging, is warranted on any rally.”

With sell signals in place, maintaining higher levels of cash, hedging, and holding fixed income continues to provide benefits. 

This is particularly the case given the narrowing participation in the broader market. While the S&P 500 is still holding up, that is due to crowding into the largest of market-capitalization-weighted stocks. If you look at the Valueline Geometric Index, there is substantially more damage being done beneath the surface which is supportive of falling yields as money seeks safety. The negative divergences continue to suggest a higher level of caution.

While the market did “bounce” on Friday, the media was quick to suggest it was something more than just a bounce.” Here is the WSJ:

“The move came on top of gains on Thursday and seemed to reflect a belief that, just maybe, the U.S. economy isn’t in as much trouble as some investors had feared.”

Be careful falling into that trap.

Let’s get into our analysis for this week.

Listen To The Yield Curve Message

On Wednesday, CNBC ran the following headline:

“Stocks plunged on Wednesday, giving back Tuesday’s solid gains, after the U.S. bond market flashed a troubling signal about the U.S. economy.” – CNBC

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