Do fundamentals matter? Yes, but not how you may think nor how it is taught in economics and finance. When the good jobs report came out the stock market took a dive, but when other economic indicators followed that showed weakness in the economy the stock market rallied. So with the latest real-time GDPNow 1st Quarter forecast stalling to only 0.6% growth from a forecast of over 2.0% less than a month ago, maybe we should expect the stock market to rally to an all-time high and if we dip into recession the market should not look back.
This week showed the financial tail is wagging the economic dog. The market took the good jobs report as a sign the Fed would raise rates in June – like they have been saying for some time – and this created uncertainty and front-running. But when the bad economic numbers hit, the market said surely they will wait now and the free money will continue to flow from savers to us in the form of near zero interest rates for a little while longer. And the market rallied for a day, until it remembered it was still in a correction.
It is important to remember that the smart money does not wait for events to happen, they try to front run everyone else and each other. They anticipate and move early. So selling on strength instead of buying on dips is not a bad strategy until we see how this uncertain transition in the financial system unfolds. And then there is the minor detail of a decelerating economy and negative revenue and earnings forecast in the real economy. Because fundamentals do not matter until they do.
Okay, okay, but what is going to happen to the market next week? Unfortunately my crystal ball broke, so we are going to have to look at a few charts. While diverging volume signaled the decline, it has not been useful in determining bottoms lately. Many market internals did hit their targets momentarily, but price did not. The recent market history provides some interesting insight.
The blue line is the 108-day simple moving average and has been a good indicator of the minimum correction to expect since June of 2013. Also note the long term trend line has been broken and the new trend is less steep. The TSP S fund trend (not shown) appears to have steepened and is outperforming the C fund again, but the TSP C fund (S&P 500) accounts for 80% of the market cap of the US stock market and better reflects the status of this bull market. The TSP S fund’s recent performance reflects the shift in funds away for the larger companies exposure to currency risk with the surging dollar.
The S&P 500’s 108-day simple moving average is currently at 2034 so the recent low did not tag home yet. My early target for a correction was 2030 based on the moving average and price channel. While the odds are still high that this will be the case, I believe the odds of a deeper correction increased this week based on the trip of three important drivers in the financial system: The surging dollar breaking out to a new high against the EURO, oil prices breaking down again, and the markets changing expectations surrounding the hike in interest rates. Due to these factors, I see more risk in holding equities and bonds than a week ago.
One last chart showing the depth of corrections since June 2013. Not only did all 9 corrections tag the 108-day simple moving average, they all exceeded the current correction of only 3.6%. A 4% correction which would match the three smallest corrections would take the S&P 500 down to 2032. A 5.5% correction would take it down to 2000. I do believe there is ample reason for it to correct significantly more, but we are in a record setting bull market and the momentum is strong. So fundamentals may continue to not matter, but the smart money appears to be on the move.
Where to invest? The S fund is outperforming the C fund since the smaller companies making up the index are less impacted by the surging dollar. While I see the S fund outperforming the C fund near term, any major correction in the market will impact both funds. Once the indexes reflect the strong dollar, if the bull market is intact the advantage shifts back to the C fund that benefits from stock buybacks. But risk is increasing in the unstable financial environment and conditions can shift fast. We witnessed this by the EURO/Dollar that already hit the end of 2016 forecast, the economy coming in 2% below forecast, the over 8% reduction in forward earnings estimates in a matter of weeks, the plunging oil prices, and the list goes on.
We also saw the negative correlation of stocks and bonds turn positive the week. If this continues, it means that bonds are no longer the alternate investment to equities. We knew at some point in the future bonds and stocks enter a bear market together. While it is too early to call a bear market in either, we did get a preview this week of what is to come and the expectation of rising interest rates was the catalyst.
My April Current Situation Report will be available to all subscribers and not just Full Access Members and will cover the transition to the weak season in equities. Now is a good time to sign up if you are interested in these timing alerts and updates, our bull/bear indicator, consolidated monthly reports or the TSP daily seasonal almanacs. I do not track and report on the daily noise or spam with e-mail alerts, but I will let you know of new and significant risk to your funds. I hope you join us today.