Saturday, November 21, 2015

Weekly Market Summary

Summary: The trend is up: equities ended the week about 1% from their highs. Breadth is improving and outperformance from small caps will further bolster participation. Sentiment remains a tailwind, especially for US equities. There's no compelling short term edge, but further upside into year end remains the most likely outcome. Equities have a tendency to give a good entry on weakness during the next 6 weeks;  that would likely provide attractive upside potential into year-end.

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Two weeks ago, markets were overbought after rising 12% in 6 weeks. There was a strong edge to expecting some weakness (post).

One week ago, markets were oversold after falling 3-4%, and there was a strong edge to the upside (post).

There is no compelling edge, short term, this week. Longer term, the best edge is for upside into year end. Putting those two thoughts together, the best set up would be for markets to sell off in the next week or so, giving some upside potential into year end. It may not happen, but that would be ideal.

It's not a secret that seasonality is a strong tailwind into year end. The period from Thanksgiving to year end has been higher 80% of the time, by an average of 2.2%, since 1990. The only horrible return came during the 2002 bear market (post from Chad Gassaway on this topic here).

The upcoming week of Thanksgiving is usually strong as well, especially Tuesday, Wednesday and Friday. The week after can see some of those gains given back (data from Sentimentrader).

The market has tendency to give a good entry on weakness during the next 6 weeks. The chart below highlights a drop during December in each of the last 4 years. The lower panel shows the one week percentage change. There have been drops of 2-4% each year in December. All of the drops put SPX below the close from the week prior to Thanksgiving.

The earlier the drop comes, the better. In 2012, markets were weak through mid-November, then rallied. The drop came the week of Christmas and put December negative for the month.

One reason that drop may come sooner rather than later is this: when SPX is up more than 1-2% during an OpEx week (as it was this week), then the following week is down more than 60% of the time (data from Rob Hanna; his post here).

There is conflicting evidence for this week; there is no preponderance of extremes that indicate a strong short term edge. When there are no extremes and the trend is higher, as it is now, then the most likely outcome is higher prices. Markets tend to rise over time, with a natural upward bias week to week of 60% over time.

SPY ended in the middle of its range; it's only about 1% from the top of the channel that has marked strong resistance. Momentum is not yet overbought, so there's room to move higher. Both SPX and DJIA crossed back above their 200-dma this week.

Monday's low could be looked at as yet another 'higher low' from the August sell-off. So, it would be very informative if SPY exceeded the November high (211.7), making a 'higher high.' This would be further confirmation of the uptrend. And while the 212 area has been resistance the past half year, the more times that area is tested, the more likely it is to break and SPY to go higher.

Adding weight to that scenario is the leader, NDX. It made a new high in November and is now just 1% from an even 'higher high'. Again, exceeding the prior high would be further confirmation of the uptrend.

NDX had a 'golden cross' this week, where the 50-dma crosses above the 200-dma. The index has a high propensity to add to gains over the next 6 months following a golden cross.

A 1-2% pullback would put SPY between 205-207. Note the rising trendline from Monday's low and the stair steps higher. If those stairs start to overlap, the most likely first level of support is near 207 (also the weekly pivot) and then the next step lower at 205 (also the rising 200-dma).

Breadth is not yet overbought. About 70% of SPX stocks are above their 10-dma; over the past 5 years under these conditions, the index has closed higher within the next 5 days about 90% of the time (data from Index Indicators).

Likewise, less than 70% of SPX stocks are above either their 20 or 50-ema; there is room for these to expand to 80-90%, levels reached in early November. Here, too, we will learn something valuable in the days ahead: strong markets can withstand 'overbought' breadth and weak markets fail before becoming 'overbought.' Exceeding 80% breadth would be confirmation of the trend higher.

The media has been obsessed with the markets being driven only by four companies, the so-called FANG stocks - FB, AMZN, NFLX and GOOGL. So it's noteworthy that XLI (industrials) closed at a 5 month high this week; IYT (transports) closed at a 3-month high and both financials (XLF) and materials (XLB) very nearly did so on Friday. There are no FANGs in any of these sectors.

Transports appear to be in a bullish ascending triangle (data from John Murphy).

That's not to say that breadth is strong, but it's wrong to say that only technology is pushing the market higher. It looks like breadth may be expanding, which is the most typical pattern during an uptrend. Most uptrends start with narrow breadth, as has this one, as investors begin by crowding into their favorite stocks.

Moreover, breadth has a tendency to improve into year end. Why? Because small caps stocks have a tendency to outperform in 4Q and 1Q (lower panel). Rising small caps expands overall breadth statistics (upper panel).

Outside the US, the European STOXX 600 closed at a 3-month high this week, as did the Nikkei. The least favored region in the world, emerging markets, gained 5%. Fund managers have the second lowest allocation to EM in the past 10 years, conditions which in the past have led to outperformance (data from BAML; more on this topic in a new post here).

Similarly, fund managers have remained stubbornly underweight the US equity market for most of 2015, during which time the US has outperformed. This continues to be a tailwind for the US on a relative performance basis.

A risk in a rising market is investors becoming overly bullish. That's not happening, yet. Last week's swoon tempered investors' sentiment. Bullishness dropped in surveys from II, AAII and NAAIM (here). Moreover, equity fund flows were negative for a second week in a row (here). There has been a net outflow of money since the August low; this is usually a bullish sign, so long as equities are rising.

Insiders, on the other hand, are becoming more bullish. This is a positive. Insiders aren't always right - no one is - but their timing has tended to be very good (more on this here; data from Barron's).

Volatility has been falling. It has a natural tendency to fall on Fridays. On further weakness, we will be watching the term structure; the stock market has a propensity to give back its gains when VIX:VXV falls below 0.8 (lower panel).

Gold fell 0.5% this week. We showed a chart of a possible base last week. It might still be forming that base. Note a possible inverted head and shoulders pattern with a neckline near $104 in GLD may be setting up.

Oil lost 1% this week. USO might also be setting up a base: in the past 6 days, it has chopped in a range without breaking $12.8. That level has become an important tell.

Many commodities have a tendency to move opposite the dollar. The dollar has been very strong the past 5 years, during which time commodities have fallen. Might the dollar reverse lower? It's possible. The dollar has historically weakened after the Fed has started to raise rates, contrary to what is commonly believed (are on that here). Moreover, fund managers views on the dollar have been prescient in the past; they viewed the dollar as overvalued in March and the currency fell 7% in the next two months. They again see the dollar as overvalued (data from BAML).

On the economic calendar: PCE and GDP on Tuesday; durable goods and new home sales on Wednesday. Markets are closed on Thursday and close at 10am (PST) on Friday. Trading activity usually falls markedly starting Tuesday of this holiday shortened week.

In summary: The trend is up, breadth is improving and sentiment remains a tailwind, especially for US equities. There's no compelling short term edge, but further upside into year end remains the most likely outcome. Equities have a tendency to give a good entry on weakness during the next 6 weeks;  that would likely provide attractive upside potential into year-end.

Our weekly summary table follows.

Enjoy your Thanksgiving holiday.

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