The markets are extremely overbought, volume has lagged significantly on both the NYSE and NASDAQ exchanges during this rally, and all the major indexes are sitting at the level of previous peaks. Bearish sentiment has returned to a low level that as a contrary indicator indicates caution. With the end of the earnings season’s strength, another top should set in.
The SP500 was turned back 12 times over the summer from its current level. If you count back to 2014, you will see the Wilshire 4500 index (TSP S fund) was turned back six times from its current level. The markets are at significant overhead resistance and need to work off some of the overbought condition.
Many analysts are presenting charts that show rare occurrences such as the SP500 near its recent highs while the number of companies above their 200-day moving average remains low. This highlights poor market breadth with a few large up-trending companies that heavily influence the index outweighing the majority of companies that are in downtrends. Let’s take a closer look.
Divergences that opened up prior to the August swoon have returned. During the summer, the SP500 was held up by the mega-cap stocks. By mid-summer the smaller non-SP500 stocks (TSP S fund) started diverging to the downside. Today, the small caps remain in a significant downtrend from their summer peak while the SP500 has returned to near its all-time high.
In late July just prior to the SP500 final peak, the largest-of-the-large NASDAQ companies diverged from the rest of the NASDAQ-100 companies. A shift was occurring from small to large, then mega caps prior to the correction – a flight to safety in size and lower valuations. We see this again today.
Over the last ten days, the largest-of-the-large NASDAQ companies have once again advanced ahead of the rest of the NASDAQ-100 – thanks to Microsoft and Facebook this time. The mega-cap’s earnings season strength helped lift the SP500 back to the elevation of its many summer peaks.
November’s seasonals turn weak after the first four trading days when a post-earnings lull begins and typically the markets give back some of their earnings season rally. Again, another caution flag. With earnings announcements behind us, what will the markets focus on.
Diverging monetary policy…again
The Fed is giving its strongest signals that they WILL finally raise rates in December. I think this time is different and they will follow through. Why? Their credibility depends on it and so they changed their model’s inputs to comply with their desire to raise rates in December. In other words, their models jumped based on some tweaks and now say “raise rates” – funny how that works.
The ECB is hinting at increasing Quantitative Easing in December and the Fed is planning to raise interest rates for the first time in 10 years – yes 10 years. So again we face diverging monetary policies from the rest of the world. This should lead to a stronger dollar and weaker SP500 earnings expectations. This will also put significant pressure on emerging currencies, economies and markets and increase global financial stress.
Could the central bankers have something up their sleeve
Has the Federal Reserve developed some tools to handle financial crisis and instability. Instability is how the Federal Reserve describes a steeply falling stock market (but not a steeply rising market). They’ve been talking about developing these tools. China and Japan simply buy into their stock markets. How easy. Better yet, have some other money printing central bank buy into your stock market.
Looking back, 1998 was similar to 2015 in many respects – an aging bull market with a slowing economy and a significant fall correction. After the 1998 correction and once the markets approached their previous highs the SP500 stalled on the 5th trading day in November for about a week. Then it surged into the end of the year and on to the market top in 2000. Some are pointing to this possibility. I do not see it re-occurring – there are differences.
If one takes market risk into account when investing, now would not be the time to buy.
Join us for a more in-depth look.