New Market Highs = Last Hurrah?
Cam Hui | Apr 27, 2015 02:19AM ET
Trend Model signal: Neutral
Trading model: Bearish
The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"
My inner trader uses the trading model component of the Trend Model seeks to answer the question, "Is the trend getting better (bullish) or worse (bearish)?" The history of actual (not back-tested) signals of the trading model are shown by the arrows in the chart below. In addition, I have a trading account which uses the signals of the Trend Model. The last report card of that account can be found here.
All-time highs a last hurrah?/h3
The NASDAQ and SPX closed at all-time highs (ATH) on Friday. While new highs are generally interpreted bullishly as they are signs of surging momentum, momentum factors have not been working lately and the ATH could also be seen as warning signs for bulls. The last time the SPX and COMPQ made ATHs together was December 31, 1999 - a sobering thought!
Despite the signs of apparent strength, I stand by my assertion that US stocks are in the process of making an intermediate term top. Stephen Suttmeier of BoAML recently warned about the risk of a cyclical top within a secular bull based on past historical patterns.
In the past few weeks, I have also been writing about how the stock market price trend is looking extended and short-term momentum appears wobbly. My analysis was based on a study done by James Paulsen of Wells Capital Management .
Such conditions typically see a price reversal in the next few months (see How to make your first loss your best loss).
Nick ) indicates that global earnings estimates are also falling.
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Despite these warning signs, my base case scenario does not call for a full-blown bear market, but a correction much like the experience of 2010 or 2011. The chart below shows a stylized depiction of where different countries are in their economic cycles. While there may be a few minor quibbles about the exact positions, the key takeaway here is that the US is in the mid-cycle phase of an economic expansion and a recession, which is the major catalyst for a bear market, is not on the horizon.
Analysis based on sector leadership points to a market that is being held up purely by risk appetite, or speculative sentiment. I pointed out in my last post that Consumer Discretionary stocks looked a bit wobbly on a relative basis (see Someone is going to be very wrong on the American consumer). While these stocks have recovered a bit of relative strength, what struck me was that the relative weakness of Consumer Discretionary stocks was widely based and across the board.
Using the same techniques for measuring relative strength, I went looking for signs of market leadership to measure where the market believes the pockets of economic strength are.
So what`s holding up this market? Surprisingly, it`s the high-beta glamour groups of the stock market ( via the SPDR S&P 500 ETF (ARCA:SPY), PowerShares QQQ Trust Series 1 (NASDAQ:QQQ), iShares NASDAQ Biotechnology ETF (NASDAQ:IBB), Global X Social Media ETF (NASDAQ:SOCL), Renaissance IPO (ARCA:IPO) plus Healthcare via Health Care Select Sector SPDR (ARCA:XLV), which has shown a consistent pattern of relative strength).
The relative strength of a number of key sectors, such as Financials, defensive sectors—Consumer Staples and Utilities (via Financial Select Sector SPDR (ARCA:XLF), iShares US Broker-Dealers (NYSE:IAI), Consumer Staples Select Sector SPDR (ARCA:XLP), Utilities Select Sector SPDR (NYSE:XLU), Energy Select Sector SPDR (ARCA:XLE), SPDR S&P Metals & Mining (ARCA:XME))—and resource sectors, do not show any sign of leadership either. The disappointing relative performance of the heavyweight Financials and its high beta cousin the broker-dealers is disappointing. Moreover, analysis from Nautilus Research says that this kind of relative weakness in financial stocks is a bad sign for stock prices going forward.
The lack of defensive leadership is a sign that the bears aren`t about to stage a major charge. Resource stock relative strength is stabilizing, but they do not appear to be ready to stage a major advance yet, as they probably need time to base and consolidate.
What about cyclical sectors? Meh! The chart below depicts the relative strength of Industrial stocks (also equal weighted because of the influence of heavyweight GE), semiconductors (and growth cyclical Technology stocks), as well as the the transportation sector (via Industrial Select Sector SPDR (ARCA:XLI), Guggenheim Invest S&P 500 Equal Weight (NYSE:RSP), Technology Select Sector SPDR (NYSE:XLK), Market Vectors Semiconductor (NYSE:SMH)). In particular, I have also been watching the DJ Transportation Average as its weakness could be the sign of a Dow Theory sell signal. While the DJTA has been weak, it has been able to hold above a key support level, indicating that the market is still in a holding pattern.
So let`s summarize. The market leaders are mainly the glamour, high-beta names. The "engines" of the economy, such as the cyclical industrial and semiconductors, financials and consumer discretionary stocks are not leading the market. On the plus side, defensive sectors such as Staples and Utilities are not showing signs of leadership either. In other words, Mr. Market is telling us not to expect much from the economy, but don`t get overly panicked because of the lack of defensive leadership.
It is ever rising risk appetite that is propelling stock prices to new highs, as they lack fundamental support. Mark Hulbert had some bad news based on the readings of his Hulbert Stock Newsletter Sentiment Index (HSNSI):
To put the current HSNSI reading into context, consider that its average level since March 9, 2009, when the bull market began, has been 39.4%, only slightly more than half the current reading. In fact, over the past decade, there have been only two occasions when the HSNSI was higher than it is today, and on both occasions the market proceeded to fall:
- End of 2013/beginning of 2014: The Dow Industrials fell more than 1,000 points in a month’s time, or 7.3%.
- February 2015: The Dow Industrials fell 600 points, or 3.2%.
To be sure, those are only two data points. But they are consistent with the pattern that has emerged over the past 15 years. As you can see from the accompanying table, the Dow on average has done better following readings of 0% and under when it’s been as high as it is currently.
In addition, ISE option data:
The CNN Money Business Insider ) shows that asset class price movements have becoming increasingly correlated. A repeat of rate hike anxiety could derail markets in a highly disorderly way.
Bottom line: There will be much event-driven volatility this coming week, but the risks are tilted to the downside. My inner investor remains cautious but not panicked. My inner trader remains short.
Disclosure: Long SPXU, SQQQ
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.
/h3
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