Review & Update
In last week’s missive, I discussed the breakout of the market.
“The breakout does keep our allocation model nearly fully allocated. We are holding onto a little larger than normal cash pile just to hedge some volatility risk during the summer months.Also, stops have now moved up to the bottom of the bullish trendline as shown in the chart below which coincides with the 100-day moving average which has been a running support line.”
The “sell signal” currently remains in place from very high levels, and with a push into 3-standard deviations above the 50-dma currently, we remain cautious for now.
However, there is no denying the “bullish bias” currently remains in the market, and the sharp push higher reconfirms the underlying trend. Because of that “bias,” we remain allocated towards risk in our portfolios.
The biggest problem I have currently is simply that bonds are NOT buying the rally. As I discussed last week, and as we saw on Friday, bonds continue their “bullish bias” and broke through key support levels suggesting lower rates to come.
With interest rates still overbought, and on an important “sell signal,” the downside break from the recent consolidation process will likely prove problematic for stocks going forward as the flight from risk to safety continues.
But, as we discussed a couple of week’s ago, this is a very “confused market” with both offense and defensive sectors taking the lead. As shown in the “spaghetti chart” below, there are currently 8-sectors leading the S&P 500. More importantly, the “riskier” small and mid-cap markets continue to remain weak which is certainly not the backdrop to support a strongly running “bull.”
This really is a more bizarre clustering of markets and sectors that I have witnessed in quite some time. However, for now, the rotation between sectors remains tight and it is the #FANMAG stocks that continue to elevate markets because of their sheer size. ($FB, $AAPL, $NFLX, $MSFT, $AMZN, $GOOG)
The question that continues to linger over the markets is just how stable is the advance? The answer to that question is unclear, but it is quite likely the spat of earnings growth seen over the last couple of quarters will soon end as year-over-year comparisons get decidedly tougher.
Considering that earnings estimates are generally overstated by roughly 30%, the actual net decline in earnings growth will likely be far sharper than currently anticipated. More importantly, since the bulk of the increase in earnings estimates were based upon tax cuts/reforms, when it becomes apparent those legislative policies are not forthcoming, earnings estimates will be ratcheted sharply lower. With the market trading well ahead of earnings growth currently, the risk of disappointment is extremely high.
Lastly, given that much of the recent rebound in earnings came from the sharp rise in oil prices, with those prices once again on the decline, it is quite likely forward earnings are overly optimistic currently.
