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By Pete Biebel, Senior Vice President

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Those tall colorful plastic cylinders with wild hair and waving arms are apparently called “air dancers.”  They’ve been around for years.  You’ve seen them weaving and dancing in front of all sorts of businesses: car lots, restaurants, resale shops, funeral homes.  Okay, maybe not funeral homes but they are nevertheless unnaturally pervasive.  Their telepathic messages shout, “Shop here!”  “Look at this!” “You don’t know what you’re missing!”  I’m thinking they should put a few of those things out in front of the New York Stock Exchange: “Great deals!”  “Don’t miss out!”  “Zero percent financing!”

Those air dancers seem to be a good metaphor for recent stock market activity on a couple different levels.  One is that the antics of a relative handful of stocks have advertised spectacular things happening within the NYSE and other stock exchanges.  Just a few headline-grabbers have inflated the averages and have accounted for all of the gain in the S&P 500 Index (SPX) year-to-date.  They have projected the impression that everything is awesome and great fun can be had by all.

Not to beat the point into the ground, but those air dancers are often seen in front of businesses that tend to have a rather ram-shackled appearance.  “Look at these bargains!  Pay no attention to the wobbly floor.”  Despite all the fanfare of the leading names, many, in fact most of the other participants aren’t looking so good.  59% of the SPX stocks have year-to-date losses as of Friday’s close.  67% of the Russell 2000 Index of small-cap stocks (RUT) are in the red for the year.  And, 65% of the 3536 stocks in the S&P Total Market Index are likewise underwater.

A “Wall Street Journal” article last weekend suggested that a market dominated by a relative handful of stocks could be a bad omen for future returns.  It included a chart that supported the theory that a widening divergence between cap-weighted and equal-weighted indices often preceded a big market decline.  It also surmised that, while periods of concentrated leadership are not unusual, the current situation, in which the leading companies are all tech-related, might merit a heightened degree of caution.

The constant stream of air required to inflate the tubes and keep them dancing is supplied by the Fed in this metaphor.  With interest rates at zero, markets get the support of free money.  The Fed has also been pumping liquidity into other markets including investment-grade and junk bond markets.  All that money’s got to go somewhere.  The U.S. stock market is a favored target.  Consider that the dividend yield on SPX is currently more than double the yield on Ten-Year Treasuries.  So, the Fed’s liquidity flow is certainly helping to keep the averages inflated and the market dancing higher.  The obvious threat is that when the pump is shut off, the air dancer collapses.  The market currently expects that the Fed’s free money will continue for another year or two.  Any significant change in that presumed policy could bring the market’s dance higher to an abrupt end.

Last week, the dance continued.  All the indices shot higher on Monday’s opening fueled by headlines like, “Futures Rise to All-Time Highs After Chinese Liquidity Injection,” Many of the leading performers got back on their feet after sitting out several sessions over the past month or so.  Recall that DJIA outperformed COMP in four of the previous five weeks.  The NASDAQ Composite Index (COMP) leapt 2.65% for the week.  COMP hit new intraday and closing highs several times during the week, including Friday.  SPX tip-toed a mere 0.72% higher, just enough to enable it to finally exceed its February record high, though by just a whisker.  It was the fourth consecutive weekly gain for SPX, its longest positive streak this year.  The Dow Jones Industrial Average (DJIA) was just flat for the week.  The opening minutes of trading on Monday set the high of the week for DJIA.  Weakness in big banks and a few of its aerospace and defense companies took some of the air out of DJIA’s performance.

COMP and SPX tacked higher through the week with just one setback of significance.  The averages fizzled lower midweek in a two-hour sell-off following the Fed policy announcement Wednesday afternoon.  The three sectors that have been leading the market higher, Communication Services, Consumer Discretionary and Technology, were the week’s biggest gainers and by a wide margin.

One troubling phenomenon noted in recent weeks, the deteriorating market breadth, was even more evident last week.  Several of the week’s winning sessions were ones in which the number of declining issues greatly exceeded the number of gainers.  On Friday in particular, when all the broad indices posted gains for the day, the ratio of declining issues to advancers was two-to-one negative on both the NYSE and the NASDAQ.

The increasing appearance of speculative excess in the stock market is another factor that should make us question how much longer this bullish dance can continue.  I recently pointed to the extremely bullish readings in option trading statistics as a bearish contrarian indicator.  Now there also seems to be a lack of speculative bearishness, which is probably also a bearish indicator as a contrarian signal.  A report from Goldman Sachs last Friday stated that short interest in the median S&P 500 stocks has just hit its lowest level in their sixteen years of tracking that statistic.

COMP and SPX are at record highs even as market breadth continues to narrow.  The concentration of activity into fewer and fewer winners may be another sign of the more speculative nature of recent trading.  It seems to indicate that the flood of free money is mostly chasing stocks with good upward momentum.  Many of the same sort of stock-picking tools that professional traders have used over the years are now available to everyone.  Even brand new traders with a hankering for speculation could easily find any number of stock picking sites online.  Most of the stock screening systems used by short-term traders focus on a few technical factors to identify buy candidates.  Most operate on the theory that a stock in motion will remain in motion, irrespective of “value.”  Some will favor stocks whose short-term moving averages are the furthest above their long-term moving averages.  Some will look for stocks with the best short-term performance relative to SPX.  The end result is that all these systems wind up concentrating their activity in a very narow group of stocks.  So, when the market is in a speculative mood, the money continues to flow into the leading names irrespective of value.

It keeps working until it doesn’t.  Since the March low, there hasn’t been any indication that the uptrend was reversing.  Now, with COMP stretched to about 25% above its 50-week moving average and more than 50% above its 200-week moving average, I’m reluctant to bet that it’s going to continue working much longer.  There’s no reason yet to be bearish, but there are increasing signs that it might be prudent to be a little cautious.  Talk to your advisor about the pros and cons of lightening up on some your winners or placing stop-loss orders.

With the major broad indices at new highs, there is no overhead resistance; the sky’s the limit.  SPX ended Friday just a few points below 3400.  That leaves the index comfortably above the 3200 level, which I believe is the nearest intermediate-term danger level.  On a shorter-term basis, SPX would probably have to drop below 3360 before any minor alarms would sound.

In closing this week’s article, in which the “hook” or theme involves high-pressure air and inhuman, mindless jesters, I want to assure you that there is nothing political in my mention of Congress.  Traders will be watching the negotiations in Washington D.C. for hints of progress on a new stimulus package.  The market expects that another package is inevitable, just the timing and the final price tag are in question.  The list of economic reports due this week is lengthy.  Several, including the Durable Goods data and Initial Jobless Claims, could produce a surprise that briefly roils the markets, but Thursday’s GDP number will be the highlight of the week.

Date Report Previous Consensus
Monday 8/24/2020 Chicago Fed National Activity Index, July 4.11  
Tuesday 8/25/2020 Case-Shiller Home Price Index, June, M/M 0.0% +0.1%
  FHFA House Price Index, June, M/M -0.3% +0.3%
  Consumer Confidence, August 92.6 93.0
  New Home Sales, July, SAAR 776K 774K
Wednesday 8/26/2020 Durable Goods Orders, July, M/M +7.3% +4.3%
  Durable Goods Orders ex-Transportation, July, M/M +3.3% +2.0%
Thursday 8/27/2020 GDP, 2nd Qtr., SAAR -32.9% -32.9%
  Initial Jobless Claims 1,106K 987K
  Pending Home Sales, July, M/M +16.6% +1.5%
  Kansas City Fed Manufacturing Index, August 3 2
Friday 8/28/2020 U.S. Goods Trade Deficit $70.6B $73.0B
  Personal Income & Outlays, Income, July, M/M -1.1% -0.2%
  Personal Income & Outlays, Consumption, July, M/M +5.6% +1.5%
  Wholesale Inventories, July, M/M -2.0% -0.6%
  Chicago PMI, August 51.9 51.8
  Consumer Sentiment, August 72.8 72.8

 

Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.

August 24, 2020 |