As we noted Thursday, the damage to the weekly charts has been relatively minor thus far. Our model readings Friday said “exercise some patience” with long positions relative to their outlook over the coming weeks.
Lows Made Early In Sessions
On Thursday, the S&P 500 made its low for the day nine minutes into the trading session. On Friday, the session low was made roughly 30 minutes after the open, meaning buyers stepped in during the rest of the day. Friday’s close was very close to the high of the day. Thursday and Friday did not look like “panic selling”. The trends remain up but we will keep an open mind about bearish outcomes next week.
Our master CCM Risk Exposure Model, which includes some new rules, calls for very limited reduction in risk (0% to 3%) based on the deterioration that was present Thursday morning. We also ran each of our holdings through the CCM Trend Following Model, which also has a set of recently added rules. The results are similar with the Trend Following Model; it allows for a very slight reduction in risk; we could cut our exposure by 2.85% based on a full allocation of 100%.
Weekly Close Most Important
Since the models rely heavily on weekly charts, we will check everything again Friday. If we need to make some adjustments to stay aligned with the rules and models, we will do so before Friday’s close. A push down to 1628 on the S&P 500 would not be out of character for an uptrend. A close Thursday above the 1655-1657 range would be a minor win for the bulls.
The initial reaction to Ben Bernanke’s prepared remarks was positive. At the high Wednesday, the S&P 500 was up 18 points. Then during the Q&A, Bernanke hinted the Fed may slow the printing press sometime in the coming weeks or months. The whole tone of the markets turned on a dime and the S&P 500 dropped 38 points. It closed down 13 points.
Defensive Action vs. Bullish Trend
We did sell two positions to raise cash Wednesday. Immediately after the open Thursday, we will update our models and evaluate the extent of the damage to the current bullish trend. The markets have seen periods of sharp volatility since the November 2012 low, but have recovered in short order in each case (see below).
The chart above tells us to respect volatility but to also respect the current trend, which remains up. If deterioration occurs that puts the uptrend in doubt, we will take significant defensive action. If the pullback falls into the category of “acceptable volatility”, we will take limited defensive action in order to participate in any subsequent gains.
CCM Models
Thursday’s model readings will help us determine reasonable and prudent steps based on the severity (or lack thereof) of the declines. If an intermediate-term correction or long-term bear market is starting, our models will help us move to safer havens at a reasonable rate. If this is another short-term scare to be followed by higher highs (see chart above), our models will allow us to retain meaningful exposure.
Since the S&P 500 made an intraday low of 1,536 on April 18, the widely-followed stock index has tacked on 130 points and the markets have migrated back to full-bore risk-on mode.
Wednesday Winddown?
Two key events this Wednesday could give investors an excuse to book some profits:
Federal Reserve Chairman Ben Bernanke will speak before Congress.
Fed minutes are due to be released.
There appears to be little evidence to suggest Bernanke will drift from his recent guarded optimism stance on the economic outlook, which means his comments may be stock market-friendly. On the Fed minutes front, the release is based on the meeting when the statement “The Committee is prepared to increase or reduce the pace of its purchases…” was added. The key term was “increase”. Therefore, the minutes may prove to be dovish or stock market-friendly as well.
Hard To Predict Market’s Reaction
Even if we had advance copies of Bernanke’s speech and the Fed minutes, it would be difficult to predict the reaction of the fickle financial markets. Therefore, the best way to handle Wednesday’s Fed-related events may be to see how traders react and make allocation tweaks if needed.
Bulls Have Tight Grip
With unprecedented and simultaneous intervention from central banks in the United States, Europe, and Japan, one of the best ways to stay aligned with money making opportunities is to simply pay attention to what is happening and what is working. As demonstrated in the video below with various charts, ratios, and markets, what “is happening” is the bulls are in complete control.
After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.
Aston Martins and Acquisitions
The bull/bear debate always comes down to the risk tolerance and confidence of investors. Bloomberg reported a 1961 Aston Martin Jet took in a record $4.85 million at auction last weekend, which tells us someone is confident. Similarly, Yahoo’s reported acquisition of Tumblr shows companies are willing to trade cash for what they see as growth opportunities.
Weak Dollar Script Not Working
In recent weeks, we have been favoring U.S. stocks over emerging markets (EEM), precious metals (GLD), and commodities (DBC) due in part to ongoing strength in the U.S. dollar (UUP).
The “risk-on” script over the past several years has been for “weak dollar” assets, such as emerging markets, to lead during periods of increasing risk appetite. With a strong U.S. dollar in play, emerging markets continue to lag the S&P 500 rather than lead (see below).
Materials: The Most Important Sector?
As we will cover shortly, stocks recently broke out in a bullish manner relative to bonds. Materials stocks, a recent market laggard, are trying to complete a similar push higher. When laggards begin to “catch up”, it is typically a good sign for the entire stock market. As shown in the chart below, the materials ETF (XLB) was turned back at several points of logical resistance over the past two years (see red arrows). The green arrow highlights a breakout above a typically bullish chart pattern know as a “triangle”. If materials continue their ascent, the S&P 500 could push significantly higher.
Risk-On Beating Risk-Off
The monthly labor report released in early May gave many investors renewed economic confidence. A logical and often pondered question is would I rather be in stocks or in bonds. The stock/bond ratio below [(SPY) vs. (IEF)] rises when stocks are in greater demand relative to bonds. Conversely, the ratio falls when investors have a greater desire to buy bonds relative to stocks. The red arrows below show numerous occasions during the last two years where stocks failed at logical points of resistance. The green arrow highlights a breakout above a typically bullish chart pattern known as a triangle. The chart below also represents a bullish breakout by risk-on relative to risk-off. As long as the chart below maintains its bullish look, we will favor stocks (VTI) over bonds (TLT).
Investment Implications
As noted in the charts and video above, the bulls have a firm grip on the markets (as of the close on May 20). Using the “pay attention to what is happening” approach, as long as conditions continue to favor bullish outcomes, we will favor stocks over fixed income instruments. If emerging markets and materials stocks can begin to show leadership, we would also be more inclined to favor economically sensitive or cyclical ETFs, such as financials (XLF), over more defensive sectors, such as consumer staples (XLP).
Since we noted numerous weekly divergences were cleared in a bullish manner in this May 4 video, the S&P 500 has gained 52 points. After reiterating the bullish set-ups in this May 10 video, the S&P 500 added 32 points in the past five trading sessions.
Bullish Charts on Twitter: On Friday, we added a few links to bullish charts on Twitter (click here).
New Video Coming Sunday: We will be posting an updated video this weekend - look for a link here or on the CCM Twitter Feed.
The chart below shows junk bonds (higher risk of default) relative to Treasury bonds (lower risk of default). As of Tuesday’s close, the ratio continued to side with the bullish camp for stocks.
The chart above is described in detail at the 8:46 mark of last weekend’s video (click to view the segment).
As we noted Monday, the vast majority of charts used in the CCM Models are favoring stocks over bonds looking out several weeks. The chart below, as of Monday’s close, shows a healthy weekly S&P 500 trend.
It remains important for cyclical assets, such as materials stocks, to attract enough buying interest to complete bullish turns.
The market’s recent shift back into economically sensitive assets tells us stocks could continue their surprising march higher despite the ongoing calls for “sell in May”. As shown in the chart below, the S&P 500 made no progress during the last twelve years. The “no progress” pattern was recently broken, which could lead to head-scratching gains in the months ahead.
Market Has Responded To Economic Data
The financial markets were pleased with the widely-anticipated monthly employment report that was released in early May. Monday’s session was greeted with a better than expected number on the retail front. From Bloomberg:
Sales at U.S. retailers unexpectedly advanced in April, helping ease concern of a sustained pullback in consumer spending that would stifle the economy. Retail purchases climbed by the most in four months minus receipts from service stations, where cheaper gasoline prices depressed the dollar value of sales.
Confirmations More Upside Likely
In the world of chart reading, known as technical analysis, “confirmations” occur when two or more charts support the same conclusion. Breakouts can fail. Therefore, we would feel more confident about the S&P 500’s recent twelve year breakout if other charts and areas of the market seem to fall in the bullish line. This week’s video covers twenty areas of the market that align with or serve as a “confirmation” of the S&P 500’s recent march higher. Chart analysis begins at the 2:43 mark.
After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.
Volume Confirms Market’s Push Higher
When large market players, such as hedge funds, place a bet, they make large trades which are reflected in daily and weekly trading volume. When we track volume, we are indirectly tracking where the “big boys” are placing their bets. The chart below ($NYUD) shows more volume has been associated with advancing stocks relative to declining stocks, which is another way of saying the big boys have been more interested in buying rather than selling. Notice how $NYUD, like stocks, has broken above a multiple-year base.
Breadth Regains Bullish Footing
The period between late January and mid-April 2013 was marked by a defensive bias in the markets, despite the S&P 500’s advance. The defensive undertones can be seen in the chart of market breadth below. Market breadth speaks to the percentage of stocks participating in a rally. When a high percentage of stocks participate (strong breadth), it is a sign of a healthy market. Conversely, when breadth is weak, it casts doubt on a rally’s staying power. Notice how the concerns about weak breadth have been removed since the Summation Index ($NYSI) reversed sharply in mid-April.
Shift Back Toward Cyclical Stocks
Cyclical stocks tend to be more sensitive to the strength of the economy. One example is Harley-Davidson (HOG). Rational people tend to put off the purchase of a $15,000 motorcycle if they are concerned about job security. The chart below shows economically sensitive stocks (SPHB) were weak relative to defensive stocks (SPLV) during the ten week period between early February and mid-April of this year. Since then, the market’s tone has shifted noticeably in the bulls’ favor.
Small Caps Show Growing Confidence
Small caps are another area of the markets that is shifting back toward the “we’re confident” end of the spectrum. When investors migrate back toward smaller (read riskier) companies, it signals renewed hope for positive economic outcomes.
Intermediate-Term Outlook Positive
Even the under the most bullish conditions, stocks experience various forms of backfilling. Therefore, if the bullish signals above remain in play, we should still expect pullbacks from time to time. However, the odds favor a continuation of the longer-term trend, which is bullish.
Investment Implications
As long as conditions outlined above remain in place, we will favor cyclical areas of the market over defensive sectors. Cyclical ETFs include high beta (SPHB), consumer discretionary (XLY), retail (XRT), technology (QQQ), semi-conductors (SMH), home builders (ITB), energy (XLE), financials (XLF), small caps (IWM) and mid-caps (MDY). Defensive sectors tend to underperform under these conditions, meaning we would tend to avoid or underweight consumer staples (XLP), utilities (XLU), and healthcare (XLV).
Major Wild Card: Fed Policy
There is absolutely zero question the Fed’s aggressive money-printing and bond-buying programs have played a major role in the market’s recent advance. A not-so-subtle objective of the Federal Reserve’s use of quantitative easing (QE) is to boost asset prices. If the Fed dials back its bond purchases and the markets react in a negative manner, the entire investment landscape could be flipped upside down. A May 11 Wall Street Journal article paints a very uncertain picture relative to the Fed’s exit strategy, especially on the timing front:
Officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated.
Should the markets have a Fed-induced return to “risk-off” mode, the charts above will experience an observable change in character. In a world where asset prices are heavily impacted by intervention from central banks, maximum flexibility is an ongoing requirement for investors.
Short Takes is a stock market blog updated regularly by Ciovacco Capital Management, LLC. This financial blog covers investing topics, such as economic cycles, stocks, commodities, currencies, and technical analysis.
