E How Do Cash Holdings Turn Into Equity Holdings?

For the year, the S&P 500 is up nearly 18% and the month of June is proving to be the best June on record since 1955. For June alone, the benchmark index is up 7.7 percent.

It took the S&P 500 just 13 trading days to go from closing below its 200-day moving average to setting a new all-time high. Rather remarkable even if it wasn’t the first ever occurrence. Just in the past 20 years, these were faster: (OddStats)

  • July ’16 – 9d
  • Oct ’14 – 10d
  • Mar ’00 -5d

One other fun fact you might be interested in with regards to the S&P 500’s performance and history. 

As shown in the chart above from LPL Senior Market Strategist Ryan Detrick, it is interesting that the S&P 500 hasn’t gained more than 20% in any one year for 5 consecutive years. “Only once since 1950 did it go more than 5 years in a row without gaining 20%, thus if this pattern continues we very well might get to 20% in 2019.”

In determining whether or not the June rally is a “healthy” rally we can look at just how many sector ETFs are trading above their 50-day moving average. Most every ETF is trading above their 50-day moving average shy of the energy sector, which has been hindered by the slide in crude oil prices.  This past week, however, crude oil jumped as Iran/U.S. tensions elevated with Iran shooting down a U.S. drone. 

What is also apparent from looking at the Bespoke Investment Group Trend Analyzer depicted above is that defensive sectors are leading the market higher.  All defensive sectors are expressing extreme overbought conditions presently while the cyclical sectors and industrials are lagging, but remain over their 50-day moving average. (Finom Group, for whom I am employed, had suggested buying shares of XLV at $85.78 more than a month ago to Premium members. Since that time it has appreciated 10 percent. I anticipate selling the position in the coming week).

In addition to sector ETFs signaling the June rally to be a healthy rally, the NYSE A/D line continued to hit new all-time highs this past week (bottom chart). Remember, historically the NYSE A/D line peaks out well ahead of the S&P 500 price (top chart). It was making new highs last week and has continued to make new highs. Simply put, with the NYSE A/D line continuing to march higher, there doesn’t appear to be any technical warnings for the market presently.

If we are to layer onto the rally a neutral reading of 57 for the S&P 500 14-day RSI, we would suggest more gains are in store for the S&P 500, even if not right away. One of the issues that may prove to cause a headwind for the S&P 500 and peer indices near-term is the onset of earnings season that is anticipated to show Q2 earnings declined on a YoY basis. In addition to an earnings headwind, Friday’s quad-witching day tends to highlight structural adjustments to the major indices that plagues the following week’s performance.

As shown in the chart below from Bloomberg TVthe week after a quad-witching Friday the major indices are usually found to decline. The declines aren’t terribly significant, but in 25 out of the last 29 years, all three major averages have declined after a quad-witching day.  The reason for the declines is that demand diminishes in the options pit.

Given the statistics around a quad-witching Friday, investors shouldn’t be surprised if the markets do in fact give up some of their YTD gains and after closing the week near all-time highs.  I mean if you don’t believe in “option pinning” folks, then maybe you think the SPX closing at 2,950 means nothing? 

With the aforementioned in front of mind for the coming week, Nomura’s Charlie McElligott offers a possible scenario. He sees the S&P 500 sliding next week only to spike even higher, predicting that near-term moves may head-fake sentiment in the coming days. “It is worth noting that there is a ‘sequencing risk’ set-up with this week’s trade into next week and thereafter which could head-fake sentiment”:

  • Witness this type of “force-in grab” into Stocks on account of the powerfully dovish CB moves this week, on top of the remarkable Equities “under-positioning” I’ve been highlighting the past few months
  • This then corresponds with the already VERY bullish analog/seasonality for SPX into the June serial Op-Ex (tomorrow), as options overwriters roll their in-the-money calls out and thus create big notional Delta to buy
  • But then dangerous the week AFTER Op-Ex (next week), you lose this overwriter “Delta buying” impulse (1w after June Op-Ex SPX perf -1.4% median and 87% of time LOWER, contingent on rallying the 1m into Op-Ex) and 37% of the Gamma expires tomorrow ($4.2 of the $9.4B at this monster 2950 SPX strike)
  • Additionally you then too see the downgrade to the corporate buyback “bid,” as we are now deeply embedded within the “Buyback Blackout” window (over 75% of SPX companies within their blackout now)
  • The market then risks “mis-reads” this potential FLOW-CENTRIC weakness in Equities next week as some sort of “fading the Fed”—when in fact it’s almost entirely mechanical in nature
  • This type of head-fake could, in fact, see more shorts added and sentiment purge, which then perversely is the fodder for a melt-up into SPX 3000s

We’ll have to wait and see if any near-term equity market and sentiment damage takes place. Let’s face it; sentiment isn’t all that bullish presently anyways.  Moreover, recent analysis and forecasting from McElligott hasn’t born fruit as Finom Group has chronicled. Remember McElligott’s failed “Ides of March” market sell-off thesis?

The most near-term risk to the market rally is the G-20 Summit meeting between President Trump and President Xi.  To reiterate, I believe the base case scenario is a trade truce that includes:

  • Agreement that no additional tariffs will be levied by either country
  • Timeline is set in place to remove certain restrictions placed on Huawei’s business operations with regards to U.S. suppliers and buyers.
  • Additional timeline for monitoring improvements made by China with regards to intellectual property theft
  • Agreement to increase commodity purchases from the U.S. by China

Since the trade war began, it has loomed large over the equity markets. Figure 2 shows the U.S. manufacturing PMI rising during the first phase, and then steadily dropping during the ‘trade war’ phase. With the recent escalation of the trade war, the decline in manufacturing PMI accelerated and could enter contraction territory unless there is progress on trade. We see a similar impact in equity markets. Before the trade war, equity markets were rising at an above-trend pace and then stayed unchanged for ~18 months. If one takes that the average annual return of US equities was ~7% (current capitalization of ~$30T), the estimated cost of the trade war so far is about ~$3T. This may be a conservative estimate as many market segments benefited from flight to safety and declining yields, and without the temporary rally in “safe havens,” the market would likely trade lower. The market damage is ~100 times the tariffs collected, so it is clearly not making the country richer. The impact of the trade war was particularly negative on segments that were its intended beneficiaries, such as manufacturing (autos, electrical equipment, etc.), smaller domestic companies, steel industry, etc. (JPM)

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Alpha Stockman 1 year ago Member's comment

A very long read but worth it.

Seth Golden 1 year ago Author's comment

Thank you very much!