A Normal Pullback?
It is normal and to be expected for bullish trends to experience pullbacks or retracements. Typically, a healthy trend will see countertrend moves that remain above the three major Fibonacci retracement levels shown below. As of April 17, the S&P 500 ETF’s (SPY) post-election rally remains in the “normal pullback” zone.
Is The Bigger Picture Showing Some Bearish Cracks?
This week’s stock market video reviews the impact of the recent pullback on the longer-term outlook. The video also covers the emotional impact of portfolio drawdowns.
A Bearish Reference Point
The chart below shows the S&P 500’s 100, 200, and 300-day moving averages during the stock market’s topping process in late 2007/early 2008.
The same moving averages as of April 17 are shown below. Our concerns would increase if the chart below started to morph into a look similar to the chart above.
Is The Trump Trade Overcrowded And On The Ropes?
Given the Trump trade is based on expectations for reduced regulation, lower taxes, and faster economic growth, if investors had moved all their chips to the Trump table, we would expect strong outflows in defensive-oriented bonds over the past several months. According to The Wall Street Journal, skeptical investors are racing toward bonds at a record pace:
Investors are buying record volumes of new bonds, signaling that many remain skeptical about the prospects for faster economic growth and are reluctant to move on from a strategy that has worked for years… The strong appetite for bonds shows how hard it is for investors to shake the assumption that the economy can do any better than muddle along as it has for years, with U.S. real gross domestic product growing less than 3% a year.
What Can We Learn From Similar Bond Binges?
As shown via the green annotations added to The Wall Street Journal image below, two other periods that featured a cluster of record high spikes in bond sales were near points A (October 2002) and B (March 2009).
The S&P 500 (SPY) chart below shows the same points A and B in The Wall Street Journal chart above. The spikes in demand for new bond offerings (A and B) coincided with two of the best buying opportunities in the stock market over the past 20 years. Therefore, it is difficult to draw any bearish conclusions about stocks based on the recent surge in demand in the primary fixed-income market.
Is The Trump Trade Alive And Well Or On The Ropes?
This week’s video uses facts, rather than opinions, to examine the health of the stock market (VTI) and Trump trade (SPHB). After reviewing the facts, you can make your own call.
Are Trends Flipping In Favor Of Bonds?
When fear dominates the entire investment landscape, investors begin to migrate toward more defensive assets, as they did in late 2007. Notice in the top portion of the image below, defensive-oriented bonds (TLT) started to gain significant traction relative to growth-oriented small caps (IWM) several months before the S&P 500 peaked (red arrow). The same bond:small cap ratio on April 10, 2017 shows a trend that continues to favor small caps relative to bonds. The look of the chart below may change, but it has not changed yet.
Are Investors Overly Optimistic?
When investor sentiment hits extreme levels, it can be a contrary indicator for stocks. Are investors sending alarming euphoric signals in 2017? Not according to the latest American Association of Individual Investors (AAII) Sentiment Survey.
Going back to 1987, the average percentage of bullish respondents is 38.5%; today the figure sits well below at 28.3%. Rather than being well below average, the present-day percentage of bearish responses is well above average; 39.6% bears today vs. the historical average of 30.5% bears. These figures are more in line with fear rather than complacency.
This Is What Increasing Fear Looks Like
The chart below shows the S&P 500’s 100-day moving average (blue), 200-day (red), and 300-day (green) during the transition from a favorable period to an unfavorable period (2005-2008). Moving averages allow us to focus on longer-term trends rather than inevitable day to day volatility.
Charts cannot predict the future; they simply help us better understand the odds of good things happening relative to the odds of bad things happening. The left side of the chart above shows a more favorable look with blue, the fastest moving average, on top and the slopes of all three moving averages are positive (bullish trends). The right side shows a lower probability look with blue, the fastest moving average, on the bottom and the slopes of all three moving averages are negative (bearish trends).
How Does 2017 Compare To The 2007-2008 Peak?
The charts below allow us to look at markets through an unbiased lens. Reviewing the trends below requires no discussion of politics, the Fed, or our personal views on any topic. Do trends in 2017 look more like a favorable period (point A in first chart) or an unfavorable period (point B in first chart)?
A Major Shift Has Occurred In The Markets
This week’s video covers three important developments and provides a big picture historical context (1980-2017). Like the charts above, the charts in this week’s video speak for themselves.
Does the Dow look more like a favorable period or unfavorable period? You can decide using the charts below.
In early October 2007, just as the S&P 500 was peaking, financial stocks’ (XLF) 100-day moving average (blue) dropped below both the 200-day (red) and 300-day (green), telling us the odds of bad things happening had increased relative to the odds of good things happening. How close is the 2017 100-day to dropping below the 200 and 300-day? The answer tells us something about the strength of the long-term trends in 2017.
When we take a longer-term view, the trends in small-caps (IWM) and mid-caps (MDY) remain in the favorable camp.
The same concepts apply to the April 2017 version of the NASDAQ’s daily chart.
Bullish Trends Make Higher Highs
By definition, a bullish trend makes a series of higher highs and higher lows. Therefore, if the trends shown above remain in place, the S&P 500, Dow, XLF, IWM, MDY, and the NASDAQ will eventually make higher highs after the current pullback. To illustrate the concept of higher highs and higher lows, we will focus in on the left side of the chart below, during the bullish phase.
The chart below shows only the bullish phase (2005-2007). Notice how the pullbacks are followed by higher highs. Compare the look of the moving averages during the bullish trend below to their look in April 2017.
A quote from the book Market Wizards provides some additional insight:
“Investors tend to confuse short-term volatility with long-term risk. The longer the time period, the lower the risk of holding equities. People focus too much on the short term, week-to-week and month-to-month price changes, and don’t pay enough attention to the long-term potential.”
The 2017 moving averages below help us stay focused on the long-term potential.
Is it possible the trends flip over in a bearish manner? Yes, it is very possible. However, the evidence we have in hand today (see charts above) does not support an imminent trend reversal. If the evidence shifts, bearish odds will begin to increase. That may happen, but it has not happened yet.
Video should be available late this evening, sometime in the midnight to 1:00 a.m. EDT neighborhood (more on video topics here).
Small Caps: Nothing Alarming Yet
Small caps (IWM) and banks (XLF) rallied after the U.S. election based on expectations for reduced regulations under the Trump administration. As shown in the chart below, the recent weakness in small caps falls into the “normal pullback within the context of an ongoing and established bullish trend” category. Small caps, as of this writing, remain above all three major Fibonacci retracements (Fibs) based on the pre-election low (point A).
How Concerning Is The S&P 500’s Pullback?
This week’s video covers a prudent and rational manner to monitor risk during inevitable “givebacks” or portfolio drawdowns. The S&P 500’s present day profile is compared to the August 2015 pre-plunge profile, allowing us to better understand the odds of a similar waterfall decline following the tabling of the healthcare bill.
Are Banks On The Ropes?
Like small caps, thus far, the pullback in financial stocks has remained above all three major Fibonacci retracements based on the pre-election low (point A). The odds of a longer-term bearish trend change would improve if XLF drops below the third major Fib near $21.25. On Monday, XLF was trading at $23.36.
Banks: 2007 vs. 2017
The Fibs help us monitor the probability of the current bullish trends continuing relative to the odds of a new bearish trend developing. The slope of XLF’s 200-day moving average helps us monitor the strength of the long-term trend in banks/financial stocks. The top chart below shows the long-term trend rolling over in a bearish manner in 2007; the bottom chart shows the present day trend.
Facts vs. Emotions