The Bull Is Firing On All Cylinders

Summary

• All major sectors are participating in the broad recovery rally.
• Even the lagging banks and energy stocks are now on the mend.
• Credit spreads are also showing vast improvement as liquidity increases.
• Watch for the rise in the major indices to accelerate this summer.

The new bull market which began earlier this spring is now in full swing, with all major sectors confirming its strength. In this report I’ll make the case that the market is in far better shape now than it was even before the coronavirus panic. And with liquidity as profuse as ever, the upward trend in the major indices is likely to accelerate as we head into the summer months.

Worry is alive and well when it comes to the U.S. economic and financial market outlook. That much remains clear based on a daily perusal of the major headlines, as everything from pessimistic GDP projections to stock market crash predictions continue to dominate the news media. One such example of this persistent pessimism can be seen in a CNBC article from Monday, which reported that over half of global corporate executives surveyed expect the Dow to fall below 19,000 - its pre-coronavirus crash level - before it’s able to reach a new all-time high.

But now that a new bull market has been clearly established, I regard evidence like this as good news from a contrarian’s perspective. The implication of articles like the one mentioned here is that there’s plenty of skepticism to prevent another crash since investors are clearly on their guard and haven’t over-committed to stocks.

Even more compelling than the continued worries among participants has been the remarkable outperformance in the tech sector lately. The Nasdaq Composite Index is on the precipice of making a record high as it has already recovered its losses from the February-March panic. Tech leadership is of paramount concern for the bull’s health and is always encouraging given its outsized importance in today’s economy. Indeed, a case could be made that tech groups like the semiconductors have supplanted the transportation stocks as being critical confirming indicators for the Dow 30 Industrials. The bottom line is that it’s always a welcome sign when the Nasdaq is showing relative strength versus the Dow.

Source: BigCharts

It’s not just the large-cap industrial and tech stocks that are doing well, though. Even the sectors that were showing relative weakness versus the S&P 500 Index in the last few months are showing signs of improvement. Consider for instance the energy stocks, which were loss leaders heading into the March panic. Almost every day starting in January, a large number of energy sector stocks were dominating the new 52-week lows list on both major exchanges. Since April, however, energy stocks have disappeared from the new lows and are now increasingly participating in the rally. Here you can see the solidly bullish performance of the Energy Select Sector SPDR ETF (XLE). More than perhaps any other market segment, it’s vital that the oil and gas stocks are healthy since it reflects well on the U.S. economic outlook.

Source: BigCharts

Consumer discretionary stocks are also on the mend, as can be seen in the chart of the SPDR S&P Retail ETF (XRT). The rally in the retail sector is of vital importance and points to the likelihood of a strong economic rebound during the coming months. A failure of the retail stocks to rally would be a troubling sign indeed and would provide some credence to the pessimists’ belief that the rebound is doomed to fail. As it stands now, however, retail sector strength is undermining the bears’ thesis.

Source: BigCharts

Another critical area of the market which is starting to show improvement are the financial stocks. Banks and broker/dealers are breaking out after spending several weeks stuck in neutral. Many observers feared the worst when the economically-sensitive bank stocks largely failed to participate in the April-May portion of the broad market rally. But now, banks and brokerage stocks are catching up with the other sectors as the economy roars back to life. Shown here is the Financial Select Sector SPDR ETF (XLF).

Source: BigCharts

Skeptics will no doubt attribute the latest revival in the financial sector as merely the product of short covering. Dispelling this cynical view, however, is the significant improvement in the high-yield debt arena. Not only are “junk” bond prices rising as yields on risky debt decline, but high-yield credit spreads are also telling us that informed bond investors are increasingly confident about the corporate outlook. Shown here is the ICE BofA U.S. High Yield Index Option-Adjusted Spread, a useful liquidity indicator. After spiking to multi-year highs during the panic, it has been rapidly dropping as “smart money” traders increasingly turn bullish on corporate credit.

Source: St. Louis Fed

As I mentioned in a previous report, once this spread drops below the 6% level it will let us know that the remaining stress over credit conditions has completely dissipated. And with an abundant supply of liquidity in the financial market, credit conditions should quickly return to pre-crisis levels in the coming weeks, which in turn would provide an even better backdrop for equities to kick off another extended rally this summer.

Yet another important sign confirming that the bull is firing on all cylinders is the recent performance of the new 52-week lows on the NYSE and the Nasdaq. On both exchanges, new lows remain well below the historical “line in the sand” levels of 40 per day (anything above 40 lows suggests abnormal internal selling pressure). In the last several sessions, for instance, new highs have outpaced new lows by a very healthy margin. Moreover, on most days the new high-low ratio has averaged 7:1 on the Big Board.

Thus, the internal picture for equities is far more benign now compared to how it was leading up to the March crash. Here’s what the NYSE 4-week highs-lows rate of change (momentum) indicator looks like as of this writing. As you can see, it’s still in a rising trend and in positive territory. This tells us that the near-term path of least resistance for stock prices is still up, thus favoring the bulls.

Source: WSJ

With the most economically sensitive market segments making huge strides in recent weeks, all signs point to the bull market firing on all cylinders. Historically, momentum traders are most likely to achieve success when there is across-the-board participation in all the major sectors and key industries, which is now the case. Further, with participation broadening, the odds favor an acceleration of the rally as we head into summer. In view of the variables we’ve reviewed here, a bullish intermediate-term (3-6 month) posture toward equities is therefore still warranted.

Analyst’s Disclosure: I am/we are long XRT. 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.