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  • Bloomberg TrendStall Sell signals triggered this week for major indices.
  • Timing indicators remain elevated and suggest further weakness ahead.
  • Weakness should be contained given credit market health and economic data.

In my Monday article I highlighted how the market's advance was strengthening and broadening out as the biggest sectors of the market that had lagged for the greater part of the year were beginning to gather momentum and become short-term leaders. Although this is a constructive development, I warned how the market was getting a little overheated as several of my intermediate-timing gauges had reached frothy levels, implying we either consolidate or experience a small pullback.

This was further confirmed this week as a number of major market indices received a Bloomberg TrendStall "sell signal" (see red triangles) as shown below.

Source: Bloomberg.

Reviewing my market indicators on the Russell 3000 Index (~98% of the entire U.S. market capitalization) shows we are just coming off elevated levels (see red circles) and suggests further market weakness in the days ahead.

Source: Bloomberg.

While I expect some near-term digestion in the markets as they work off an overbought condition, I wouldn't expect fireworks to the downside given how tame the credit markets are. Shown below is the TED spread, which typically resides in a narrow range until either a financial crisis or economic recession triggers an upward move from its normal range. This can be seen below in which the TED spread jumped after the LTCM crisis in 1998 and stayed elevated until the end of the 2001 recession and then again in the middle of 2007 when the subprime crisis exploded. Note the extremely benign reading coming from the TED spread currently, which suggests the credit markets remain calm and aren't signalling signs of financial stress.

Source: Bloomberg.

As shown below, we are also seeing an improving economic backdrop that confirms the message from the credit markets. Recently, the BLS's Job Openings and Labor Turnover Survey (JOLTS) showed job openings leap to levels not seen since the last economic cycle. Given job openings lead nonfarm payrolls by 6 months, we should expect to see a pickup in job growth to close out 2014.

Source: Bloomberg.

Another positive development can be seen in May's NFIB Small Business Optimism Index, which hit a 7-year high as it closes in on its long-term average of 98.

Source: Bloomberg.

This improvement in sentiment for small businesses should not be overlooked given they are the engine of job creation in this country. The small business segment consistently hires more workers than large and medium-sized firms, which is born out in the data as the ranks of those employed by small firms (1-49 employees) has more than surpassed the highs in 2008. However, medium-sized firms (50-499 employees) and large-sized firms (500+ employees) have yet to exceed the net payrolls of the last cycle.

Source: Bloomberg.

Given small businesses are the center of U.S. job creation, a 7-year high in the index bodes well for the US consumer whose confidence closely tracks the NFIB Optimism Index and suggests consumer confidence is set to accelerate higher.

Source: Bloomberg.

Given that consumer spending habits are closely tied to their level of optimism, any move higher in consumer confidence suggested by the NFIB Optimism Index should also translate to a pickup in retail sales.

Source: Bloomberg.

Summary

After a nearly uninterrupted two week rally in the stock market, we have our first Bloomberg TrendStall sell signal on the broad indices since the early April peak. These signals have been fairly reliable over the last year and suggest a period of caution as the markets digest their recent gains. Given most of my timing indicators are still at elevated levels we are likely to see weakness heading into next week's June FOMC meeting.

Noting the above, I would not expect a sharp selloff given the lack of stress seen in the credit markets and strength in the economy. There is some real momentum building in the small business segment of the economy as small business optimism surges to multi-year highs, which bodes well for the consumer and thus consumer spending. Another area of building momentum is in the job market, which has seen the pace of job creation accelerate from an average monthly growth pace of 174K in 2011 to the current pace of 214K payrolls. The pace in monthly payroll growth should accelerate even further later in the year based on the message of job openings coming from the JOLTS report.

Source: Evidence Continues To Mount That A Short-Term Top Is In