E When Does A 9-Week Market Rally Produce Fear Amongst Investors And Why?

It’s not often that such a market rally, now nearly 2 months in the making, can frighten investors, but this particular rally has served to uncover some strange happenstance when we look under the hood. With the FOMC/Fed on the sidelines and a China/U.S. trade deal seemingly on the horizon, the market fundamentals will eventually have to stand on their own accord and strength or fall due to their weakness.

Last week proved a rather uneventful week, even with the FOMC minutes released on Wednesday afternoon. The S&P 500 (SPX) didn’t move all that much last week, barely 15 points higher and well within the $35/point weekly expected move. The S&P 500 was up a scant .62% last week and is up roughly 11.5% year-to-date. Probably most importantly is that the benchmark index has rallied nearly 18% since the 2018 Christmas Eve bottom and is within 148 points of its all-time high (As of Friday's close). The S&P 500 is now higher in 8 of the last 9 weeks and has moved higher with record-setting breadth. The NYSE Advance/Decline (AD) line made another new all-time high this past week. The following chart is of the SPX (top) and the NYSE A/D line (bottom).

This is a very good sign, as market breadth tends to lead stock prices. Also, breadth breaks down ahead of major market peaks. Moreover, the Dow Jones Industrial Average (DJIA) index also broke above 26,000 for the first time since early November and posted its 9th consecutive weekly gain, its longest streak since May 1995.

I usually care very little for the Dow and its movement as it holds just 30 stocks, but something interesting has happened inside of the Dow that has forced me to recognize the liquidity that I had thought would prove favorable for equities in Q1 2019, really isn’t what has driven the market place. I'll get into that force factor in a bit, but in studying the breadth of the market rally I'm are also forced to discuss what are overbought conditions and the statistical probabilities for the market going forward.

“Yes, stocks are quite extended near -term,” explained LPL Senior Market Strategist Ryan Detrick, “but historically, extended markets have tended to deliver continued outperformance over the next several months.”

 In suggesting that the S&P 500 is overbought, I look at the number of stocks that are trading over their 50-DMA. Recently 90% of stocks within the index, which was one of the highest readings ever, have cleared their 50-DMA.

As depicted in the table above, after 90% of stocks in the S&P 500 go above their 50-DMA, their 1-, 3-, and 6-month returns actually have shown continued strength. In fact, three months after hitting that 90% mark, the S&P 500 has been higher 12 of the previous 13 times going back to 1990. Given the historical context, there is such thing as “favorable overbought conditions”. But will history be a guide for the current market rally; this remains to be seen. Many statistical probabilities proved faulty in 2018. And that brings us to a critical test for the S&P 500, as shown in the chart below from The Lyons Share.

The chart above gives us a longer-term perspective on what has already occurred within the S&P 500, as it broke below a long-term trend line. From that vantage point, we are forced to recognize one of two things, if not both. 1. A broken trend line often proves a bearish signal. 2. Breaking back above the trend line would likely serve to validate that a new bull market began recently. With some historical and technical context to the S&P 500 and Dow rally YTD, what about those ever-important fundamentals?

Economic Fundamentals

Unfortunately, much of the economic data being released in 2019 has an element of unreliability and incompleteness to it and due to the government shutdown. Nonetheless, the delta we can surmise within the data being released suggests a slowing economy both abroad and domestically.

Global economic data continues to slide amid waning demand. Markit’s Eurozone Purchasing Managers’ Index (PMI) slid to 49.2 this month, the first time manufacturing activity in the region has fallen into contractionary territory (below 50) in five years. Markit and Nikkei’s Japan manufacturing PMI also slid to the lowest in more than two years. Separate data showed Japanese exports declined 8.4% year over year in January. Exports to China were particularly weak, falling 17.4% year over year. We continue to expect economic and earnings growth in foreign developed markets to trail those of the U.S. and emerging markets (EM), and we continue to prefer exposure to U.S. and EM equities over developed international stocks.

One of the more concerning data points issued in the past week was from the Philly Fed. The Philadelphia Fed manufacturing index in February dropped sharply into negative territory. The index fell to a seasonally adjusted reading of -4.1 from 17 in the prior month. This is the first negative reading since May 2016.

Below the headline, the indexes for new orders and shipments dropped into negative territory. The employment indicator remained positive. Firms were generally optimistic about the outlook for the next six months. The question remains as to why the employment indicator and sentiment remained positive? I’ll answer that question shortly.

1 2 3 4
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.


Leave a comment to automatically be entered into our contest to win a free Echo Show.