Tuesday, December 6, 2016

Weekly Market Summary

Summary: US equities have made new all-time highs in the past week. Breadth is good. But there is a set-up for price gains to be limited (or negative) in the next 1-2 weeks.

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In the past week, SPX, DJIA and RUT have all made new all-time highs (ATH). Each is within 1% of those highs today. All of their respective moving averages, from 5-d to 200-d, are rising. This is the definition of an uptrending equity market. Enlarge any chart by clicking on it.

The trend higher is not perfect. It rarely is. In this case, the technology-heavy Nasdaq index is lagging. In particular, NDX is presently below a flat 50-d. It led out of the February low, gaining 25% through October, so it could be consolidating those gains. It has largely moved sideways since August. Note how NDX has not been able to remain overbought in the past 4 months (top panel).

It's hard to find fault in breadth. All 6 cyclical sectors (financials, technology, discretionary, industrials, energy and materials) have recently made 1-year highs. The equal-weight SPX index is at an 18-month high relative to the market capitalization-weighted index. The laggards are defensive sectors (healthcare, utilities and staples).

The macro environment is supportive of longer term gains in US equities (a recent post on this is here).

Valuations are rich. This is a potential long-term headwind. But sales and earnings are once again growing after a false "earnings recession" brought about by the collapse in the price of oil. By some measures, profit margins are at a new high (a recent post on this is here).

So, is the coast is clear? Not quite.

Volatility has plunged by half since the election. That in itself is not a headwind, but 1-month protection is now trading at less than 80% of 3-month protection for the first time since September. When this has happened in the past, SPX has tended to chop sideways for the next 1-2 weeks; any gains have tended to be given back (shading).

Moreover, investors are leaning towards excessive short-term bullishness (longer term bullishness, as measured by equity fund flows and fund manager cash, are supportive of further gains in equities; read further here and here). The trailing 1-month equity-only put/call ratio is now at a level where every rally since August 2014 has stalled.

Importantly, the equity-only put/call ratio could continue to fall. In the chart above, it is clear that this has happened many times in the past prior to August 2014. It takes bulls to make a bull market. This is not a mechanical set up.

December is well-known for having a bullish seasonal bias. But those gains have, on average, accrued in the second half of the month. The period from now and for the next 1-2 weeks has typically been weak (from Stock Almanac).

That pattern has been the case, for example, the past several years. Declines have been between 3% and 5% (blue shading). A similar drop now would bring SPX to its 50-d at around 2150. The last exception was in 2011 (green shading); in that year, SPX had ended a 5% drop on November 30th.

So, there's a set-up for US equities to be weak (or to at least trade sideways) in the next few weeks. With equities trading higher again today, there is no price reversal to trade against. A price reversal could be marked by a high wick candle or by price closing under it's 5-d and the slope of the 5-d flattening and then inverting. Importantly, neither of these has happened yet. On a hourly basis, the index has remained more frequently 'overbought' and infrequently 'oversold' in the past month. This is a sign of strength in trend (top panel).

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