“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.
“Twas just nine days to Christmas, when all through the Fed there was not a worry in the economy, so they said.
With Wall Street complacent and investors without a care, they all waited patiently for a rate hike, just a quarter point seems fair.
Declines in Junk bonds, Transports, Imports, Exports…who cares. There is FaceBook, Amazon, NetFlix and Google in the air.
From Wall Street To Main Street came the call, it’s time to ‘buy, buy, buy’ one and all. We have lots of positions to sell you, after all.
With hopes set high by one and all, the question is now will ‘Santa come to visit Broad and Wall?'”
As Christmas fast approaches, the hopes of a year-end “Santa Rally” fills the airwaves. Just this morning Jeff Saut, the “raging bull” from Raymond James announced that “investors should get ready for a ‘rip your face off-type rally.'”
As I have discussed at the beginning of November:
“With the markets currently oversold on a very short-term basis, the current probability is a rally into the ‘Thanksgiving’ holiday next week and potentially into the first week of December. As opposed to my rudimentary projections, the push higher will likely be a ‘choppy’ advance rather than a straight line.
In early December, I would expect the markets to once again pull back from an overbought condition as mutual funds distribute capital gains, dividends, and interest for the year. Such a pullback would once again reset the market for the traditional ‘Santa Claus’ rally as fund managers ‘window dress’ portfolios for their end-of-year reporting.”
Here is the updated version of that chart which shows the markets playing out very closely to that previous projection.
However, while the seasonal tendencies suggest that the markets will push higher through the end of the year, there is no guarantee that such will be the case. However, the recent sell-off, as noted in the chart above, did push markets back into enough of a short-term oversold condition to facilitate a fairly healthy bounce.
What will be most important is whether the market can break above the downtrend line that was established from the market highs this past June. As I will discuss today, there is mounting evidence that the market is in the process of building a significant market top that could play out in 2016.
Signs Of A Market Top
While I do suspect that the markets will likely end positively by year-end, it is the underlying deterioration of the market that continues to concern me.
As shown in the chart below, the markets have been consolidating over the past year as liquidity from the Fed has been extracted and discussions of further “tightening” of monetary policy have ensued.
If this was just a “pause that refreshes,” the consolidation process would not grossly impact underlying indications of market health. For example, note in the long-term chart below of the number of advancing versus declining stocks. During “pauses” in market advance, the indicator continues to trend positively. Only during topping processes does the deterioration become more evident.
Importantly, the warning being sent from “junk bonds” is also being widely dismissed as noted by Scott Grannis yesterday:
“Markets are once again in a tizzy over junk bonds, mainly of the oil variety. The situation in the oil patch is pretty dicey, no doubt about it, but aside from that it’s hard to find much genuine distress. Lots of panic selling in a few areas, but no systemic distress. From the looks of key indicators, this is not a replay of 2008.”
“The chart above shows investment grade credit spreads as measured by the Merrill Lynch Corporate Master Index, as of Dec. 11th. Spreads are somewhat elevated, to be sure, but they are not even close to the distressed conditions we saw in late 2008. They are about the same today as they were before and during the 2001 recession, which was the mildest on record.”
Scott is correct as investment grade bonds are not at levels seen during the last half of the “financial crisis.” However, there are two points to be made. The first, is that rise in spreads denotes early distress in the bond market which has acted previously as an early warning sign to a spreading contagion into the stock market.
Secondly, as Scott aptly notes, while the recession was mild in 2001, the early signal given by the bond market warned of the onset of a significant bear market in stocks. The same was true in 2007 had the warning only been heeded.
Furthermore, momentum continues to tell the story of a market that has reached maturity. As shown in the chart below, price momentum on a monthly basis is registering a signal only seen during more pronounced market tops.
This can also be seen in a longer term view of market topping process since the turn of the century.
Relative strength in the market is also flashing warning signs of a late-stage bull market advance rather than a market in the midst of a mid-cycle advance.
While it is certainly possible that we could see a “rip your face off rally” through the end of this year, most of the internal market indicators are suggesting that such a rally should be faded as we head into the new year.
With the current bull market cycle well advanced, valuations elevated and economic underpinnings deteriorating, there are many signs that suggest that we may be nearing the completion of the first half of the full-market cycle. The problem that most investors face is understanding when to shift from “greed” to “fear.”
With the Federal Reserve now focused on tightening monetary policy in the year ahead, further extracting liquidity from the financial markets, the risk of a correction has risen markedly. While it is certainly not popular to suggest that investors become more cautious, I would be remiss not to point out the risks that are currently present.
However, Peter Eliades, the technical guru at Stockmarket Cycles, suggested much the same during a CNBC interview yesterday with Rick Santelli.
As an investor, you should remember that making money in the market is only one-half of the job. Keeping it is the other. As Bill Henry once quipped:
“The don’t ring a bell when its time to sell.”
Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter and Linked-In