Market Commentary June 26

The Week Ahead: Will “Bubbleland” Fears Trigger Heavier Selling?

The 8% drop Friday in Shanghai Composite set the tone for many of the markets on Friday though some were able to buck the trend. The Shanghai is now down over 20% from the high just made earlier this month. With just a few days left in the quarter many opinions are being voiced on where the market will be going in July and in the 3rd quarter.

The sentiment was quite a bit different in two of the other key global markets even though the ups and down in Greece’s debt negotiations did cause an increase in volatility. The German Dax Index did not seem troubled over a possible default by Greece as it closed the week up almost 4%. The Nikkei 225 also continues to act strong as it made a new multi-year high last week gaining 2.6%

Carl Icahn closed out his large wining position in Netflix (NFLX) for a reported $2 billion profit and then commented that the “market was extremely overheated”. This was followed by comments later in the week by well known investor Jeremy Grantham who said that ” most stock markets in the world are overpriced — and the bond market is more overpriced that at any time in history”.

Though he does not think either market is in “bubbleland territory” yet he does think they are eventually headed that way because of Federal Reserve policy. For the first time since 2013 it has been a down quarter for most bond holders and US Treasuries are slightly negative for the year.

The Markets

Despite the relatively sharp rise in yields and the decline in price most bond fund managers do not seem to be worried at this time. (Treasurys’ Swoon Doesn’t Rattle Debt Investors) From a technical perspective I think one can make a case that they might be wrong .

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The weekly chart of the 10-Year T-Note shows that the downtrend from the early 2014 high, line a, was broken on June 3rd. Yields have continued to move higher with next key resistance at 2.563%, line b. A close above last September’s high yield of 2.64% would really get the market’s attention. It would take a drop below the 2.09% area (point 1) to reverse the uptrend.

I have always thought that bond investors should always look at income investments technically as well as fundamentally. My fear is that many bond fund holders are not prepared to see a capital loss in their fund that is greater than the yield they were counting on when they bought the fund.

The Vanguard Total Bond Market Index (VBMF) is one of the largest bond mutual funds with total assets of $145.2 billion. It has a current yield of 2.34%. It is now down 0.53% for the year and 2.04% for the past three months.

The weekly chart shows that the uptrend, line c, was broken in the middle of May. On the long term chart one can make the case that the high in late 2014 was the right shoulder (RS) of a head & shoulder top. This would be confirmed by a weekly close well under the neckline (line d) at $10.49. The measured target from the formation is in the $9.80 area which is over 8% below current levels.

Some investors have already given up on the bond market as up through June 17th $6.6 billion has come out of bond funds and ETFs so far this month. Lipper also reports that $16 billion has gone into stock funds and ETFs.

This influx of cash has not done much to move the stock market so far and as I mentioned last week “More Signs The Economy Is Improving” the market needed a higher close this week to avoid further deterioration in the weekly studies. The individual investor has turned more bullish in the past week as it jumped 10% as 35.6% are now bullish. The bearish % saw even a larger swing as it dropped over 12% as only 21.7% are now bearish. (Look for closing US stock market coverage in the Market Wrap section)

The higher yields did cause the dollar to turn higher last week as the September Dollar Index was up over 2.5%. It closed above the prior week’s highs but the weekly studies need a further rally before they will turn positive. A stronger dollar is not going to help either the gold or crude oil market which are both looking weaker technically.

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The Comex Gold futures were down $27.80 last week and closed just above week’s low. A break of the support in the $1150 area, line a, would not be surprising. The volume on the recent rally was light as the OBV just rebounded back to its declining WMA. The OBV is well below its downtrend, line b. The Herrick Payoff Index (HPI) broke its uptrend (line c) in late May and is also below its WMA. It is still showing positive but deteriorating money flow.

Crude oil has been in a tight range for the past eight weeks which suggests the rebound from the spring lows has lost upside momentum. A drop in the September crude oil contract below $57 should trigger some heavier selling with next support in the $ 54 area. The OBV has turned a bit lower but is still above its WMA. The HPI has formed lower highs and is on the verge of breaking its uptrend. The daily studies (not shown) do look more negative.

The Economy

The data on manufacturing last week was mixed as as the Dallas Fed National Activity Index and Richmond Fed Manufacturing Index were a bit better than expected. The Durable Goods and the PMI flash reading on the Manufacturing Index did come in weaker than expected. Late in the week the Kansas City Fed Manufacturing Index was a bit better than expected but overall was still weak.

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On the housing front the Existing Home Sales hit their highest level since 2013 as they were up 5.1% in May. This is despite a slight uptick in the mortgage rate over the past month. The New Home Sales were also quite strong as they rose 2.2% which was well above the consensus estimates.

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There was good news on the consumer last week as Consumer spending rose 0.9% in May which was the best reading since August 2009. Economists are hoping that the better job market along with lower gas prices will spur even more spending in the months ahead. Friday’s 98.1 reading from the University of Michigan’s Consumer Sentiment also reflects a high degree of optimism which should be a plus for consumer spending in the months ahead.

In this holiday shortened week there is plenty of economic data starting with the Pending Home Sales Index and the Dallas National Fed Manufacturing Survey on Monday. Also we have the Chicago PMI (Tuesday) as well as the PMI Manufacturing Index and ISM Manufacturing Index on Wednesday.

On Wednesday we also get the ADP Employment Report and Construction Spending then on Thursday we get the monthly jobs report as well as Factory Orders. The markets are closed on Friday but the banks are open.

Sector Analysis

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Of the eleven sector or market ETFs that are included in the weekly table five are negative for the year and six are higher led by heath care which has been the leader all year. It is now up over 11% for the year. It was acting a bit sluggish in the middle of the month but then broke out to the upside on June 19th.

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The second best performer is the Consumer Discretionary Select Sector (XLY) as it closed at a new high Friday. It is up almost 8% for the year much better than the 2% gain in the Spyder Trust (SPY). The weekly starc+ band is at $82.35 with initial weekly support at $73.75. There is more important support at $68.39 and the 20 week EMA.

The relative performance made a new high last week as XLY has continued to lead the S&P 500 higher. The RS line broke through resistance, line a, early in the year. The OBV broke through its resistance, line b, late last year and is above its WMA. It did not make a new high last week.

The weakest sectors include utilities, transportation stocks, energy and industrials. Of course the transportation stocks are part of the industrial sector. The monthly and weekly technical studies on all of these sector ETFs is negative (see table).

\On Friday I released a monthly chart of the Energy Select Sector (XLE) which is in danger of having a very weak monthly close which is consistent with my analysis of crude oil.

Market Wrap

The major averages closed mixed on Friday as the Dow Industrials were higher boosted by a sharp gain in Nike, Inc (NKE). The Dow Utilities and Transports were also higher Friday but all were lower for the week. For the week the S&P 500 was down just 0.40%.

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For the NYSE more stocks declined than advanced with only 88 stocks making new highs and 202 stocks making new 52 week lows. The market internals over the past few weeks have deteriorated and they turned more negative this week.

For the Spyder Trust (SPY) the preliminary 3rd quarter pivot is at $208.72 and a weekly close below this level would be consistent with a further decline. There is stronger weekly support at $206.68 with the weekly starc- band at $204.22. The March low at $202.51 which is 3.5% below Friday’s low.

The S&P 500 A/D line dropped below its WMA on June 5th, then tested its flattening WMA last week and looks ready to close even lower this week. This consistent with a more serious 6-10% correction as the A/D line has longer term support now at line a. The weekly OBV is still above its WMA but did turn lower this week. The monthly OBV (not shown) has not confirmed the recent highs.

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The small cap iShares Russell 2000 (IWM) continues to be the best of the major averages as it is up 7.2% YTD though it also closed lower for the week. The high last week just tested the upper boundary (line a) of what may be a potentially negative rising wedge formation.

The lower boundary of the wedge is now in the $124.40 area with the rising 20 week EMA at $123.63. The six week lows are at $122.52 with the preliminary quarterly support at $122.13. The Russell 2000 A/D line failed to make a new high with prices over the past several weeks, line c. The A/D line is still above its WMA with important support at the late May lows. The weekly OBV did confirm the price action and is well above the support at line d.

The further deterioration in the weekly studies combined with the still negative readings from teh daily studies turns the focus on the downside over the next few weeks or possibly even into August.

There are no signs that a deeper correction is the start of a new bear market or a recession as I continue to expect the economy to improve this summer. Therefore a correction should be a buying opportunity for those who want to stay in stocks until there is clear evidence that the bull market has topped out and a recession is imminent.

My advice is to keep a only keep level of commitment to the stock market that will not make you change your strategy if we do some panic selling. The early evidence suggests that the small caps and health care will continue to be the leaders once the correction is over.

Because of the 4th of July holiday there only be a brief update next Friday.

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