Yesterday (early this morning actually), we reviewed the 3rd quarter, and looked at the charts of the major asset classes and considered some of the inter-relationships. The conclusion was that we were modestly bullish on stocks. Now lets try to make a scorecard of positives and negatives, and see if it supports that position. For charts please refer to the previous post.
1. The broad technical picture is bullish in at least the short term, as stocks have broken a trading range (1030 – 1140 on the SPX) of several months’ duration and are now consolidating a position just above that trading range.
2. Market internals are mostly positive, with a majority of sector bullish percentages above their primary moving averages, and we have some bullish sector rotation going on, with leadership moving from defensive to cyclical sectors: consumer cyclicals over staples, tech and telecom over utilities, materials and industrials over health care.
3. The falling US Dollar, as we have noted, has been bullish for stocks, and it is still falling. In particular, Dollar weakness has moved oil and basic materials up in price, as well as commodities in general, so stocks that are leveraged to commodity prices have benefited.
4. Treasury bond yields, which have moved not only inversely to their own prices but also to stock prices, backed up a bit and though they fell again in the past couple of weeks, did not make new lows. We have to wonder whether the falling dollar and rising commodities will finally break the fall in yields.
1. We can’t ignore volume – here I’m explicitly rejecting the “new normal” thesis in this regard – and it points to rather heavy stock distribution. Over the past week I went back to Gann’s 1920s classic, Truth of the Stock Tape, looked at the current chart of the SPX, and asked myself, “how would Gann read this market?” I can’t escape the conclusion that he would say “distribution under way – sell short.” And lest we forget, it is, after all, October.
2. Market leaders were being distributed in the last week of the quarter. Most notably, Apple shares, but also others like Netflix to a lesser extent, and of course we had the SEC investigation of Green Mountain Coffee, which had been another leading stock. Overall, we may just be seeing some rotation in leadership to new names, but this warrants caution.
3. Financial stocks, banks in particular, have lagged badly. If you tend to believe the old dictum that there is no lasting bull market without the participation of the financials, this is a cautious signal as well.
4. The Dollar has been sold hard, and the euro is rallying on the other side, but the news flow out of the euro zone continues to be worrisome, and I still believe there are poisonous snakes in that woodpile. To me it’s a question of when, not if, someone or something in euroland blows up. That would quickly reverse the fall in the Dollar, and the stock rally as well.
5. Who can say whether bond yields will continue to fall? They have already fallen farther than many analysts believed could be possible, and though the benchmark 10 year Treasury looks like it may be finding support above 2.5%, we can’t entirely discount the possibility that they will far further. Let’s not forget that when we go bearish on bonds here, we are fighting the Fed, who have made very clear their intentions.
So there you have it. I have done my best to present the case for stocks as I see it, pro and con. Now we each have to make up our own minds, and position our portfolios accordingly. For my part, again, I am cautiously optimistic, and on balance modestly bullish on stocks…but that is my nature!