Market review 22.03.20
Time to be (broadly) bullish
Lots to discuss this week. If you’re reading this post via e-mail, it will get truncated. Head over to the blog for the full post.
For the past few months, I’ve been maintaining a short-term cautious view while acknowledging that the bigger picture is very constructive. Now all timeframes are bullish for the broader stock market.
A strong case can be made that we see a sizeable rally in stocks from here:
Weekly charts: Breakouts and false breakdowns
Monthly charts: Recent multi-decade breakouts and existing long-term uptrends
Extreme retail pessimism
Commercial hedgers bearish risk-off vehicles
Favorable macro conditions
Let’s look at each of these in more detail. I’ll be sharing 20 charts with you today.
I trade off weekly price charts, and they now are giving the green light.
NYA Weekly. I shared this chart just last week when it broke down. It now reclaimed that broken support. Regular readers know how much I love false breakdowns. It’s even better when this happens on a ticker that was the last to breakdown – giving us an even earlier entry point.
EWC Weekly. Canada was a highlight in last week’s blog post. It’s breaking out.
XLV Weekly. Breakout. Many of the top holdings in this ETF have fantastic charts (eg. LLY, UNH, MRK) and surprisingly have outperformed XLE over the past 12-months! This is a sector that doesn’t seem to be getting much attention.
TAN Weekly. False breakdown confirmed.
Often, we get caught in the daily noise and forget the big picture. But how beautiful are these monthly and quarterly charts below? They suggest a lot more upside potential for stocks.
And of course, the growth oriented QQQ is still in a long-term bullish uptrend.
MSCI Growth:Value. In my mega-trends post from late Dec, I looked at how growth made a major base breakout relative to value. Recently, we retested that base as support. Similarly, SPX:TSX and QQQ:XLE are now retesting their 2000 highs as new support. A broad equity rally could be led by tech from here.
A lot of bearish divergences were present before SPX peaked late last year. But now there’s several bullish divergences.
IWM and BTC are riskier parts of the market. They peaked a few months ahead of SPX last year but are now forming bullish divergences.
SQ Weekly. Something that wasn't present during the 1yr decline in high-growth: price bases and bullish RSI (momentum) divergences.
Both HYG:TLT and AUD:JPY are risk-on measures. They are leading SPX with breakouts.
On Twitter, @MacroCharts shares a lot of great charts for breadth and momentum oscillators. This week, the Nasdaq had its strongest 4-day breadth thrust in history (link).
Stocks are entering a historically bullish period from now until early May. I still have no idea why seasonality works but it seems to be a persistent anomaly. I’ll put this chart here and you have every reason to be skeptical of it.
I’ll also note that over the past 20 years, the Dow was up in April 89% of the time with an average return of 2.6%.
**NOTE** The rest of this post will discuss non-priced based data. You can skip to the closing notes at the end and not miss out on much. Price bakes in all information we traders need to know. It tells us what both retail and institutional investors are doing. But if you’re interested in how retail & institutions think, what makes markets move, and where we might be in the cycle - then read ahead. It can give some context for what the price charts are saying - or just confuse you.
Bullish sentiment & positioning
I discussed sentiment in more detail 2 weeks ago. Retail sentiment (as measured by AAIII net bulls) continues reading extreme pessimism.
Sentiment works because the majority seldom get it right. A year ago, there were record inflows into the high-growth ARK funds. My nieces and nephews were telling me they had put all their savings into them. That made me think: “well, who is left to buy?” (some uncle I am!). Now everyone is bearish and so the question is: “who is left to sell?”
Meanwhile, commercial hedgers (often considered the ‘smart money’) have some of their lowest positions in risk-off vehicles (VIX, USD, GLD) in the past several years.
How often have we been hearing that “stocks are in a giant bubble”? But what if I told you that stocks are at the low-end of their historical valuation range?
I’m not saying valuations are on a tradeable “support.” Just that we’re probably not in a bubble.
Why valuations eventually matter:
Late in an equity bull market, earnings yields on stocks become low (ie. valuations are high) while bond yields are high. Institutional investors rotate into bonds as the equity risk premium is insufficient. The opposite is true late in a bear market after earnings yields become high and bond yields low.
Similarly, very late in a real estate cycle, housing prices and mortgage rates become high enough that the math begins favoring renting. Housing prices enter a correction. After prices and mortgage rates fall enough, the math favors owning, and a new cycle begins.
Where are we today? Well, US small-caps and Global ex-US stocks have forward earnings yields north of 7% while US 10yr bond yields are just 2%. That’s still a sizeable equity risk premium.
Favorable macro conditions
There’s been no shortage of chatter and jitters about the Fed meeting that happened on Wednesday. People seem to think that the first instance of a rate hike will annihilate stocks. If that were true, the Fed would never be able to hike rates, ever!
Looking at the historical data, we can clearly see that during the last two rate-hike cycles, the S&P 500 rallied.
In fact, in all of the last 8 rate hike cycles going back 40 years, the S&P 500 was higher 100% of the time a year after the rate hikes began (link).
No two time periods are ever the same, but there’s lots of similarities between now and early 2016 – which was the start of the last rate hike cycle and a major low for stocks (after an initial head-fake pullback of ~10%).
3 years ago, I found a very interesting paper published both on the Federal Reserve website and in the CFA journal. It suggests that the best predictor of a recession (even better than the popular 3m/10y yield-curve inversion) is when the market’s expectations for T-bill yields 6 quarters out are lower than the current T-bill yield (ie. market expects rate cuts). Conversely, when the market expects rate hikes, it’s historically bullish for stocks.
I crunched the numbers this week, and it checks out. Below is the S&P 500 plotted alongside the forward yield spread on an inverted scale. Currently, the market expects much higher T-bill rates 6 quarters from now, which is bullish.
Finally, I’ll note that the popular 10y-3m yield curve spread is nowhere near inversion. This agrees with the previous chart and is bullish for stocks. There’s been lots of charts flying around on Twitter this week with 2y (even 5y!) on the short-end. The original creator of the yield curve indicator (Cam Harvey) advises against using anything longer than 3m (link).
The shorter-term weekly charts have now joined the bullish bigger picture. The confluence of data suggests that we could see a significant rally in stocks from here with broad-based participation. I’m happy simply holding a core position in SPY/QQQ/EWC with some smaller positions in leading sectors (eg. SLX, LAND, etc).
In a risk-on environment, I can see crypto doing very well. As of this writing, the BTC weekly chart is showing its first green Elder candle in over 4 months. We’ll need to wait for the week to close (later today) for confirmation.
Meanwhile, gold can certainly continue higher. The XGD weekly chart I shared last week held base support and can gold miners can rally from here. However, this sector is not where I want to keep maintaining my focus on.
This was my longest post yet, and we’ll end it here. If you made it this far, please give this post a like and share. Thanks for reading.
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.