The Bottom Line
Positive for Stocks and Commodity Prices
Negative for Interest Rate Sensitive Bonds
• I have been bullish since the early part of 2015 when stocks emerged out of a mini-bear market. Even when stocks fell over 10% in February of this year and it seemed like everyone was saying that we were entering a bear market, my view has remained bullish for the broad stock market.
• Short-term, the stock market is consolidation within a longer-term uptrend. The weight of the evidence suggests that this is a healthy period of consolidation or simply put, the markets way of digesting the strong gains that we have seen in stocks over the past year, leading up to the January high.
• Long-term, the weight of the evidence continues to be bullish for stocks. At some point, this will change and when it does, I will have no problem flipping to a bearish bias and reallocating client accounts to a more defensive posture. However, market technicals continue to signal that we are in a bull market and thus we should be invested in stocks aggressively.
• Bond prices have been falling as bond yields have transitioned out of a 37 year period of decline. This trend of falling bond prices will adversely affect retirees for years to come. If you are interested in receiving my E-book (Bonds – A Ticking Time Bomb) on this topic, shoot me an email and I will send it to you for free.
I continue to view stock market risk as low, thus our accounts have high stock market exposure. I have progressively increased stock exposure on market dips.
We do not hold any bond funds.
Price Action – Long-term stock market price action is positive
The broad stock market fell a little over 10% early this year and everyone seemed to immediately turn bearish. This puzzled me because from what I have been looking at, the weight of the technical evidence has remained bullish.
If I could only look at one chart, it would be the one below. The monthly chart of the S&P 500. Each candle represents one month of price data. As you can see, the last bear market ended at the beginning of 2009 and since then price has remained in an uptrending channel.
I believe it is extremely helpful to take a step back and look at the big picture. Getting caught up in the emotion of a sudden 10% drop can cause us to make mistakes and not weigh all the evidence. With this in mind, even if you know nothing about stock charts you can look at the chart below and see that there is nothing ominous about what has happened in the market over the past four months. Price is still trending higher within a long-term uptrending channel that I believe defines the current bull market. The drop that began in February happened at a logical place, right at the top of the channel. The pullback brought price down to around the center of the channel, and downward price momentum ended in April with that little spinning top candle. In addition, the 50-day moving average is above the 200-day moving average (not pictured). There is no way you can look at this price chart and say it is bearish!!!
Risk-on assets are outperforming risk-off assets and this is bullish.
It is institutional money that drives the market. These are the large pension funds and hedge funds that are managing billions that will drive demand or lack thereof. Some of these funds don’t have the luxury that we have of being able to move to cash quickly when market technicals deteriorate and that is our edge.
The long-only funds have to move to more conservative investments when they feel that the market is heading lower. During those times they will move out of more aggressive sectors like Technology and Consumer Discretionary and into defensive sectors like Consumer Staples. They also have the added difficulty of not being able to move money quickly because the quantity of shares they are buying/selling moves the market. To get out of a position could take days or weeks, where it takes us a few minutes.
So what does this all mean? It means when risk-on assets are outperforming risk-off assets, the people who move the market are bullish and that moves the market higher. Of course, the opposite is true also, which is why we monitor relative strength charts to see what sectors are outperforming.
With this in mind, below is a chart of a relative strength chart of a Consumer Discretionary ETF (risk-on sector) versus a Consumer Staples ETF (risk-off). When the Consumer Discretionary ETF is outperforming the line rises and falls when it is underperforming. As you can see the line is rising strongly; therefore, Discretionary is strongly outperforming Staples.
Institutional money managers are buying risk-on assets and this is bullish!
Stock market breadth is improving, however, we are still waiting for that breadth thrust
Market breadth has been improving over the past week and that is evident in the breadth charts. The only thing that has not happened “yet” is that we have not seen that strong breadth thrust that would signal broad market participation that is commonly seen in strong stock market uptrends. I say yet because I believe the odds favor it happening soon given that the weight of the evidence continues to be bullish. I wrote about breadth thrust in my April Newsletter – Waiting For a Breadth Thrust.
Below is a chart of the S&P 500 Advance-Decline line and it is hitting new highs while the stock market is still beneath its January high. This is a positive divergence and suggests positive market breadth which is positive for stocks.
Here is a market breadth chart that will show you what I mean by market breadth improving, however not hitting thrust levels. This is a chart that calculates the percentage of stocks hitting a new 52-week high minus stocks with new 52-week lows in the S&P 500. In the lower panel is a chart of the S&P 500. Here is what you should notice:
• The red shaded area is the last mini-bear market that ended early 2016.
• When the S&P 500 is in a strong uptrend the New High-New Lows Percent consistently exceeds 10% (Breadth Thrust).
• When the S&P 500 is weak or in a bear market the New High-New Lows Percent does not consistently exceed 10%.
• During the current correction, New Highs-New Lows exceeded 10% briefly, but there was not any follow through.
• New Highs-New Lows is improving.
Price action and market breadth are positive. Risk-on assets are outperforming risk-off assets. Because of this, we have to be bullish and aggressively buying stocks.
Now we only need a little breadth thrust to really get things going.
Craig Thompson, ChFC
Asset Solutions Advisory Services, Inc. is a Fee-Only Registered Investment Advisor specializing in helping the needs of retirees, those nearing retirement, and other investors with similar investment goals.
We are an “active” money manager that looks to generate steady long-term returns, while protecting clients from large losses during major market corrections.
Asset Solutions is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.