The last five weeks have reminded us just how sensitive stock prices can be to unwelcome news on the global trade front. I’ve argued in past reports that the market’s heightened sensitivity to the latest tariff-related headlines is also symptomatic of the weak internal condition of the NYSE and Nasdaq marketplace since April. In today’s report, we’ll discuss the welcome reappearance of good news and the simultaneous improvement in the broad market, both from a sentiment and a technical perspective. If current developments continue, as I expect, the bulls will be able to regain full control of the market’s short-term trend.
Last week saw some pivotal improvements in several segments of the stock market. For starters, the S&P 500 Index (SPX) rose 4.4% for the week after briefly penetrating its widely watched and much discussed 200-day moving average. The SPX also finished the latest week above its equally significant 50-day MA for the first time since April. Last week’s impressive performance came off the back of U.S. employment data for May, which increased expectations for the Fed to cut rates at least once this year. The market also apparently had discounted an amicable resolution to the U.S.-Mexico tariff dispute.
In the latest economic news, the Employment Situation Report for May revealed that non-farm payrolls increased by just 75,000 and was considerably below the consensus expectation of around 180,000. Average hourly earnings increase meanwhile increased 0.2%, which was slightly below consensus. On a year-over-year basis, average hourly earnings were up 3.1% versus 3.2% in April. Investors are evidently banking that the Fed will give increased consideration to the disappointing results of the employment report in its upcoming policy meetings. The latest jobs report argues for a cut in the Fed funds rate, thus assuaging investors’ fears by giving the market what it has been asking for.
The biggest news occurred after the close of trading on Friday, when President Trump announced that a deal has been made with Mexico over an immigration dispute, which allows Mexico to avoid higher tariffs. This is extremely welcome news for Wall Street, which has used the threatened 5% tariff increase on Mexican imports as an excuse to dump the stocks of industries which might suffer from higher tariffs.
Meanwhile in the Treasury market, bond traders continue to signal their collective desire for a lower Fed funds rate. While a desire for safety in the face of fear and uncertainty over the global trade outlook is one reason for the bond market’s strong performance in recent months, the bigger message is that the Fed is too tight with its interest rate policy. Shown here is the iShares 10-20 Year Treasury Bond ETF (TLH), which my favorite proxy for the 10-year bond. The powerful rising trend in TLH suggests that the Fed funds interest needs to be lowered since it has exceeded the 10-year yield.
Also still benefiting from safe-haven inflows in the face of heightened worries about the ongoing U.S.-China trade war is the market for corporate bonds. Below is the Vanguard Short-Term Corporate Bond ETF (VCSH), which is a useful vehicle for tracking the aggregate performance of higher quality corporate debt. Like Treasury bonds, corporate bond prices have also rallied lately based on flight-to-safety buying among worried investors. However, rising corporate bond prices can easily coexist with rising equity prices without undermining demand for stocks. In fact, rising corporate bond prices have historically paved the way for higher stock prices. It would be more worrying from an intermediate-term (3-6 month) perspective if corporate bonds were declining. But the rising trend in corporate bond prices has instead paved the way for a stock market recovery to begin this month, as I’ll argue here.
Let’s now turn our attention to the U.S. equity broad market. The big question on every investor’s mind right now is, “Have stocks finally bottomed?”. While the final verdict on that question is still out, there are quite a few preliminary signs to indicate that a bottoming process has begun and that a bottom could be confirmed within the next few days. Let’s take a look at this evidence.
First, we begin with my immediate-term (1-4 week) trend indicator. This indicator is comprised of six major indices, including the Dow 30 Industrials, the SPX, the Nasdaq 100, the Russell 2000, the S&P Midcap 400, and the NYSE Composite. As of June 7, four of the six indices have closed at least two days higher above the 15-day moving average. This is enough to technically confirm that a low has likely been established on an immediate-term basis. This is one of the first things I look for when evaluating the possibility that a downside move has ended.
There is also the testimony of market breadth to consider. The NYSE advance-decline (A-D) line is Wall Street’s favorite measure of breadth and it is currently still in a rising trend. The fact that more stocks have been rising than falling of late is a good indication that a widespread liquidation campaign isn’t underway right now. In other words, whatever selling pressure the market has seen in recent weeks has been relegated to only a few major industries and hasn’t spread across the entire market. That’s a comforting sign from a short-to-intermediate-term bullish perspective.
Even more important than breadth is the cumulative trend in the NYSE 52-week highs and lows. As I’ve continually emphasized in this report, the highs-lows ratio is, in my estimation, the single best way to gauge the incremental demand for equities. For when the new highs are consistently outpacing the new lows it’s an undeniable sign that the market is in strong hands and there is enough buying pressure to create some forward momentum and thereby keep the bull market alive. It’s only when the cumulative new highs-lows trend starts declining that investors should really be worried. Right now, the NYSE highs-lows index is trending higher, as you can see, and has just made a new high for the year. That’s a bullish sign in itself and one that can’t be easily dismissed. It suggests that there is strength behind the latest market rally and that the bulls are likely about to regain control of the short-term trend.
Next in importance to the cumulative highs-lows trend is the 4-week rate of change in the highs-lows. This is my favorite indicator for gauging the overall near-term path of least resistance for equity prices. For the last several weeks, this indicator has been in decline which has made it easier for the sellers to control the market. Yet in the last few days, this indicator has reversed course and is trying to establish a new rising trend. Assuming the 4-week rate of change continues to rise in the coming week, we’ll have an even stronger indication that the latest turnaround in the major indices will prove successful and that buyers have regained control of the near-term trend.
Yet another salient consideration is the 120-day rate of change (momentum) of the NYSE new highs and lows. This is my favorite measure of the intermediate-term path of least resistance for stock prices. And this indicator has clearly been on a continual rising slope – nearly approaching a vertical trajectory – for the last few months. I’ve argued in the recent past that this indicator has likely been the reason why the short sellers couldn’t gain control of the market’s intermediate-term during their (somewhat) successful bear raid in May. As long as this indicator is rising, it argues against selling short as it suggests the presence of a powerful intermediate-term momentum current below the market’s surface.
Investor sentiment is also supportive of the bull from a contrarian perspective. The market’s “wall of worry” got some much-needed repair in recent weeks and is looking better than it did in April and May. The latest sentiment poll from the American Association of Individual Investors (AAII) has revealed that 43% of its members were bearish, compared with only 23% bullish. It doesn’t get much lower than 23% bullish, and this in itself bespeaks of the absence of optimistic sentiment on the stock market. My biggest complaint up until now has been the lack of bearish sentiment. That changed somewhat in the last two weeks, and while a 43% bearish sentiment reading certainly isn’t bad, I still say it should be closer to 50% for a major bottom. Nonetheless, there have been instances in the recent past where the AAII bears were only around 42-43% at a market low, so if this is the lowest bearish percentage we’re going to see for now then I’ll accept it. At least it’s significantly above the long-term bearish sentiment average of 30.5%.
Shown here is the cumulative bull-bear differential based on the weekly AAII poll. As you can see, it’s currently at one of its lowest levels of the past two years, which is definitely a good sign from a contrarian perspective. It’s the type of reading one would expect to see around a major market bottom.
The only concern I have for the immediate-term outlook is the fact that the new 52-week lows on the NYSE haven’t quite fallen below 40 yet. The new lows have definitely shrunk dramatically from last week, yet there’s still room for improvement on this front. The fact that there are still more than 40 new lows on most days is a sign that internal selling pressure hasn’t completely diminished on the Big Board. Yet the number of stocks making new 52-week highs has drastically expanded in recent days, which is a bullish sign.
In view of the fact that there are more bullish than bearish technical and sentiment indications right now, I’m willing to overlook the persistence of the above-normal new 52-week lows – at least for now. I believe the preponderance of evidence favors putting at least some money back to work in the event the bulls decisively regain control over the short-term trend. To that end, I’ve added a new position to my short-term trading portfolio as mentioned below.
To conclude, things are finally looking up again for investors after a rough month of May. The return of encouraging news on the global trade front, along with the increased possibility of a lower Fed funds interest rate, has energized the bulls of Wall Street. The latest improvements in the stock market, particularly on the NYSE, will allow the bulls to regain complete control over the market’s short-term trend – hopefully within the next couple of weeks. Nonetheless, investors should still have a healthy cash position until all signs of internal weakness mentioned in this report have dissipated. Participants should also stand ready to deploy additional capital once the stock market gives the “all-clear” signal to buy with both hands. This will occur once the new 52-week lows on both the NYSE and the NASDAQ are further reduced to below 40 for several days.
On a strategic note, I’m currently long the iShares Core Growth Allocation ETF (AOR). AOR tracks the investment results of an index composed of a portfolio of underlying equity and fixed income funds intended to represent a growth allocation target risk strategy. The fund’s holdings include U.S. Treasury, agency and corporate bonds, as well as U.S. stock funds and equity funds which track emerging and developed markets outside the U.S. After confirming an immediate-term buy signal per the rules of my trading discipline by closing two days above its 15-day moving average, AOR on Jun. 7 also closed above its psychologically important 50-day MA on a weekly closing basis for the first time in almost a month. I’m using a level slightly under the $44.18 level (intraday basis) as the initial stop-loss for this trading position.
Disclosure: I am/we are long AOR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.