posted on 30 May 2016
Despite the litany of longer-term fundamental and economic issues that stalk the markets, the short term technical dynamics for traders still remain with bullish bias. As shown in the chart below, the markets defended important support at 2040 last week and rallied back to recent highs.
However, this rather "spiky" move in the market last week, as shown above, has become quite commonplace since the beginning of last year. Such spikes in activity have been more opportunistic for "sellers" rather than "buyers."
Furthermore, as I have been detailing over the last couple of weeks, the current price action remains very similar to that seen last November. While I am not "certain" the outcome will be the same, given that we are moving into a more "seasonally weak" period of the year, a potential Fed rate hike like last December, and a political election cycle; there are certainly enough things to worry about.
With the market back to overbought conditions and pushing on important resistance at 2100, it will be critical for the markets to advance next week above 2100. A failure to do so will likely lead to a retest of the 2040 level, a break of which, would signal a deeper decline in progress.
Stops & Hedges
I am leaving my stops in place this week at the current support level at 2040 as shown above.
Furthermore, as stated previously, I have also positioned a short-market hedge in portfolios to reduce to overall allocation to market neutral in the event the market breaks 2000. I am leaving that trigger level in place this week as a breach of such level would be a violation of both the 200-dma (currently at 2010) and the psychological support levels of 2000.
While there are many reasons to move the hedging level higher this week, given the price volatility over the last several months keeping the current level should reduce the potential for a "whipsaw" to occur.
Watching The Yield Curve
Well, that is not exactly true.
The point is that nothing in the financial markets is "ALWAYS" the case. This is particularly the issue when the yield curve is being artificially manipulated through direct Central Bank interventions.
However, as is always the case, it is the trend of the data that is far more important to investors as a leading indication of potential outcomes. As shown above, the current trend of the yield spread between the 10-year and the Fed Funds rate is not a positive one.
Since the Fed Funds rate is not a "traded" rate, we can see the same development in the spread between the 10-year and 2-year rates as shown below.
At just 1.04% there is not a lot of "wiggle room" for maintaining a positive spread. Importantly, the trend has become clearly negative as was the case prior to the last recessionary onset.
The DIFFERENCE between today and "pre-financial crisis" is that economic growth was running at nearly 5% previously versus roughly half that rate currently. This gives the Federal Reserve very little room to raise interest rates, which slows economic growth, before the onset of a recession.
Furthermore, with economic growth projections crashing, the potential for a "policy error" has risen markedly in recent months. (Chart courtesy of ZeroHedge)
Jeffrey Snider from Alhambra Partners also made an interesting point using a 5-10yr yield spread. To wit:
The last sentence is exactly correct. As I stated above, it is the TREND of the data that is far more important than the level itself.
One other important point about the potential of a Fed rate hike is that higher rates will also lead to a stronger US Dollar. As I stated last week:
Short-term portfolio management instructions currently remain:
S.A.R.M. Model Allocation
The Sector Allocation Rotation Model (SARM) is an example of a basic well-diversified portfolio. The purpose of the model is to look "under the hood" of a portfolio to see what parts of the engine are driving returns versus detracting from it. From this analysis, we can then determine where to overweight sectors which are leading performance, reduce in areas lagging, and eliminate those areas that are dragging.
Over the last several weeks, RISK based sectors outpaced performance relative to SAFETY. However, starting last week and continuing this week, that level of outperformance has begun to fade rather significantly.
HealthCare moved up from lagging to improving last week. While the primary leaders of Energy, Basic Materials, Industrials, Mid-Cap, Small-Cap and International have weakened sharply. Such action suggests the recently rally last week may well be close to its conclusion.
The sector comparison chart below shows the 9-major sectors of the S&P 500.
Last week's "beta driven" rally was enough to reverse many of the warnings discussed last week by pushing many of the sectors back above their broken short-term moving averages for the S&P 500 Index.
The same can be seen in Small-Cap International, Mid-Cap and Dividend Yielding Stocks. The chase for "beta" was clearly apparent as we headed into the end of the month.
This is interesting given the "smack-down" beta stocks received the last time the Fed hiked rates.
So, either the markets are betting the Fed will "punt" on hiking rates in June, or they are hoping that "this time will be different." The problem is that tighter monetary policy is not good for stocks, particularly high-beta stocks, ever.
S.A.R.M. Sector Analysis & Weighting
As stated above, the SARM Model is an "equally weighted model" adjusted for risk. The current risk weighting remains at 50% this week. It will require a move to new all-time highs in order to safely increase model allocations further at this juncture.
Relative performance of each sector of the model as compared to the S&P 500 is shown below. The table compares each position in the model relative to the benchmark over a 1, 4, 12, 24 and 52-week basis.
Historically speaking, sectors that are leading the markets higher continue to do so in the short-term and vice-versa. The relative improvement or weakness of each sector relative to index over time can show where money is flowing into and out of. Normally, these performance changes signal a change that last several weeks.
Last week's market action was a direct reflection of the Fed's FOMC minutes. Financial stocks picked up in performance while Staples, REIT's and Utilities continued to struggle. The movement in the interest rate sensitive sectors of the market was not unexpected as interest rates ticked up in anticipation of a June rate hike.
The last column is a sector specific "buy/sell" signal which is simply when the short-term weekly moving average has crossed above or below the long-term weekly average. The number of sectors on "buy signals" has improved from just two a few weeks ago to 17 this past week. Sectors that are on buy signals tend to outperform in the near term.
The risk-adjusted equally weighted model remains from last week. No changes this week.
The portfolio model remains at 35% Cash, 35% Bonds, and 30% in Equities.
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