Week In Review (3/21 - 3/25)

Stocks finally took a breather this week as the S&P 500 had its 5-week win streak snapped.  At Thursday's close, the index had fallen a mere 0.23%.  While the Dow Jones Industrial Average was actually able to squeak out a small gain over the holiday shortened week, the NASDAQ and Russell 2000 index felt the brunt of the minor selling with both indexes falling just over 1%.

This week's pause aside, the market surge over the last five weeks has enabled the Dow and the S&P to shoot back to near breakeven for 2016.  The Dow, in fact, is now slightly positive on the year.

It's a different story for small caps and the NASDAQ however as those indexes remain down more than 4% so far for the year.  Granted, they also had fallen the most (15%) from Jan. 1 through the February lows.

Taking a look at sector performance, utilities remain the clear leader of the pack while healthcare and financials are experiencing rather dramatic underperformance.

Some charts and links from the week that was...

Chris, from Ciovacco Capital, in a highly comprehensive video update notes that global stocks continue to make a series of lower highs and lower lows and reside firmly in a downtrend.

Chris also notes that the FTSE All World Stock Index has gone exactly nowhere in the last two years.

Steve Deppe of Nerad & Deppe Wealth Management had a fantastic piece on the S&P 500 and the "squeeze" that's underway with its Bollinger Bands.  In the past, this has been a sign of a big move being in the offing.

Mohamed El-Erian has some helpful commentary on the current wide and volatile trading range.

And we took a look at what it has meant when the NASDAQ has been up 5 days in a row.  A streak it notched this week.  We also addressed what's happened after the S&P has recorded 5 straight weeks of gains.

We hope you had a great holiday weekend and we'll see you this week.

Nasdaq Up 5 Days In A Row

As you may know, the NASDAQ posted its 5th consecutive up-day yesterday.  Earlier in the month, Rob Hanna over at the QuantifiableEdges blog put out an interesting piece after the index had put up a 4-day win streak.

He noted that this type of strength was not common when the index was trading below its 200-day moving average.  The study he shared (which you can find in the link above) showed that the index was highly likely to close below Day 4's closing price at some point over the following week.  A sign that such strength while under the 200-day would ultimately stall and offer a pullback.

Piggybacking on that idea, we ran a similar study that looked at how the index had performed since the 2009 market bottom after posting a 5-day win streak.  We decided to remove the 200-day moving average filter so as to increase the sample size and doing so returned a total of 38 5-day win streaks since 2009.  Overall, the results have an upside bias but what's interesting is looking at each year individually.  2009, 2010, 2012 and 2013 posted attractive returns over each of the time periods tested.  For instance, 2010 and 2013 each offered nine 5-day win streaks which points to the idea that there were plenty of uptrends to be exploited in those environments, especially 2013.

Meanwhile, 2011, 2014 and 2015 offered far weaker performance over all timeframes as seen below.

The takeaway for us here is that we need to be looking for clues on what type of character the market is taking on.

Are we still in the difficult chop that dominated the back half of 2014 and all of 2015?  If this is the case, traders must continue to operate in a defensive manner with shorter timeframes and holding periods and thus smaller profits.  Or, are we reverting back to more of a trending, low volatility environment like we saw in 2013?  In this type of scenario, it's more rewarding to buy strength, expand holding periods while seeking greater profit potential.

S&P 500 Up 5 Weeks In A Row - (Studies)

Last week marked the 5th consecutive positive week for the S&P 500.  Going back to the beginning of the bull market in March 2009, there's been 25 prior instances where the index has been up 5 weeks in a row or more.  

Below are all of those occasions broken out by year and the number of times such a streak occurred in that year.  We then looked at the returns on the S&P going out 1, 2, 5 and 10 weeks.

Zooming in on 2014 & 2015 specifically, notice the increased choppiness and downward bias that followed the various 5-week winning streaks (6 in total) during those years.



What seems evident from these results is that the market should be due to take a breather here in the near-term.  At the very least, a pause would give it a chance to work off the overbought conditions that have been built up over the course of this rally.

Looking longer term however, history suggests that cases of extreme strength like this have eventually been followed by more gains.  Ryan Detrick from LPL Research touched on this topic and he showed the eventual bullish implications of 5-week streaks where the index was up more than 1% in each of those weeks.  In the 11 prior instances since 1950, the index, after some very short-term (1-week) weakness, has gone on to post further gains 4 and 12 weeks later.  Strength begetting strength.

What does this all mean?  We've been patient and cautious throughout this run and wont be looking to aggressively chase strength at this point.  For us, the more prudent course of action would be to wait for a constructive consolidation before adding further long exposure.

Cracks in the Armor?

We're starting to see some cracks in this bull run off the Feb 11th intraday lows.  We have seen breadth start to dissipate in the last few trading sessions as stocks making 20-day highs (944) peaked out on 3/3/16.  Meanwhile, when the S&P made a new closing high on Friday 3/11, there were only 508 stocks making new 20-day highs.  A negative divergence for now.

The Russell 2000 has now closed definitively below the 10-day moving average.  This has served as a nice short-term trend following tool after strong thrusts in either direction.  As much as the 10-day acted as resistance during the move lower in the beginning of the year, it acted as support on the rally. The Russell is the first of the big four index's to have a definitive break of its 10-day.  It also led the charge higher off the lows which may make this even more important. 

Today we ran a study on pure price movement in the S&P 500 and coupled it with the level of the VIX to see how markets have reacted after a 10% or greater up move in a month.  The motivation being that the market is now a month removed (22 trading days) and 11% higher from its intraday low on Feb. 11th.  So we did this by looking at the S&P and VIX since 1990 on a rolling basis and examined price return from a day's close versus the intraday low 22 days prior.  Below are the results.

A few observations:

• Expect some short-term weakness after a one-month 10% up move.
• Strength begets strength looking further out
• A higher VIX is more favorable for higher returns

We remain overbought on most indicators that we follow and have some significant overhead resistance nearby.  The potential reward-to-risk at these current levels has us feeling more patient here in the short-term.  

Monday Morning Comments - Overheated?

We touched on our stocks up 50% in a month indicator a few weeks ago and highlighted how overbought the measure had become.  At the time, we stated that we weren't certain of what the reading was signaling since it happened so quickly and powerfully.  Could it be pointing to a big move higher was in store or had breadth already peaked leaving the market primed to roll over.  Well since that February 17th reading, it looks like it was signaling the former as stocks have seen a nice surge.

We wanted to circle back on this indicator and see where it stood today.  As of 3/9, the number of stocks up 50% in a month was again flashing major overbought readings.  In fact this is only the 3rd time since 2010 that this indicator has reached over 50.  The other 2 times were Oct. 28th and 31st of 2011 and  that was after the European debt crisis bear market.  The rally from the Oct 4th bear market low peaked in the short-term on Oct. 27th.  But after the Oct 27th peak the S&P 500 corrected a quick 10.4%.  It then went on to rally almost another 23% from the end of November 2011 until April 2012.

The current market has shown some similarities to the 2011 environment, particularly in its breadth thrusts up and down.  If things happen to play out like 2011, the current market is most likely closer to a short term top from which we'll see a pullback before resuming higher at some point later in the year.

2011 S&P 500

Current Market

Stocks enjoyed another week of gains thanks to Friday's big up day.

And now, with this multi-week rally in the books, the S&P 500 is down just 1% in 2016 after being down more than 10% at one point last month.

We'll see if stocks can continue to shrug off these short-term overbought readings and continue their march higher.  Have a great week.

Market Update - Looking Under The Hood Of This Rally

As part of our investment process, we're constantly looking for the stocks, sectors and asset classes exhibiting relative strength versus their peers and the overall market.  This exercise helps in understanding where the money is flowing in any given market environment.

We'll often separate industry groups into quartiles based on performance over a given timeframe and then dig within to find potential candidates for investment.  Our recent data in this area shows that the market bounce since the February 11th bottom has been led primarily by the most beaten down, "low quality" stocks and sectors.

As we've been running this data, our conclusions have been supported by studies published by the fantastic Bespoke Group and others.  For instance, last week, Bespoke shared the following stats that looked at the S&P 500's performance broken into deciles.  Their data showed that stocks that held up best from 12/31/15 to the 2/11/16 bottom have dramatically underperformed during this bounce.  Conversely, the stocks that performed the worst from the end of last year to the February bottom have done the best.  See below:

In our work, we'll break down industry groups in quartiles.   In one study, we first screened what held up best from Dec. 31st to the market bottom on Feb. 11th.  We then looked to see how those quartiles had performed from the market bottom and how many members of each landed in the top 1/4th of performers from Feb. 11th low to the end of last week.  The results are below:

1st qrt - These are the industry groups that performed best from Dec. 31st to February 11th - Only 8.3% are in top 1/4 of performance since the Feb bottom.

2nd qrt - 11.1%

3rd qrt - 30.6%

4th qrt - 50%

As you can see, these results are in total agreement with Bespoke's findings.  Another one of their studies, released just this morning, helps in furthering the thought that this has been a "low quality" rally.  They looked at the S&P 1500 and found that low priced stocks have hugely outperformed since February 11th.  A look at the chart below shows that the stocks that closed below $5/share on Feb. 11th (of which there were 52) are up an average of 58% since then!  Stocks that closed between $5-$10 are up an average of 31%.  But as you go higher in share price, the average return since Feb. 11th declines considerably.

As of today, the S&P 500 is up just over 9% since the February low of 1,810.  Yet looking back at the data of the last few years, we're still a few percentage points shy of the typical gain seen after the market has experienced a 10% or greater pullback.  Going back to 2010 there were 5 such instances (we included 2014's 9.8% drop in this study) and after their ultimate bottoms, the market rallied 15% on average before having its next "meaningful" decline.

A couple of things to note here:
1) Very small sample size
2) At Friday's highs, the bounce had gone 11% off the bottom
3) We've now met the study's minimum in terms of % gain from bottom (11%) and # of days (16).
4) We've now met 2/3 of the average gain based on this study and while there may be more upside in store, we think the easy money has been made.