So much angst yet New Highs?

The markets stumbled yesterday with blame be attributed to the surrounding future of the Italian government.  Volatility spiked and yields throughout the world saw big moves in both direction as the risk off trade set in.  In a flight to safety US bonds were bought as it remains to be seen if this is a localized Italian issue or a contagion the rest of the world will deal with.  Obviously we don't know the outcome but with US indices rallying today along with US small caps making new highs we believe this will be a contained issue.  The Russell 2k is getting overbought and is one area we are watching.  However, the other three big indices (S&P 500, Nasdaq, Dow) all have plenty of room to run before excessive conditions kick in.       

An interesting stat from sentiment trader confirms that volatility is most likely to calm down instead of continuing higher after a big 1-day jump.

When we drill down into the returns of S&P sectors over the last month we can see how it paints a mixed bag.  Defensive names and financials have been a drag on performance while technology has reasserted leadership.  Oil has been on a massive run higher the last few months but has recently corrected on rumors that OPEC and Russia will ease production caps. 

From a seasonality perspective will still remain in the weakest 6-month stretch.  However, if one traded that religiously you would have missed out on a decent month so far in equity markets.  The good news from a contrarian standpoint is that sentiment remains subdued.  The CNN Fear and Greed Index is actually showing fear while cash remains high at 4.9% based on the May BAML survey. 

In the next two days there will be a host of economic numbers released.  Based on estimates and the last data points the ISM reflects a growth environment while the unemployment rate is the lowest since December 2000.  Assuming we don't get any big surprises in the wave of data, the Fed is apt to stay on course in their hiking cycle the balance of the year. 

What does it all mean?  As breadth continues to improve and with small caps trading into new highs we want to stay long risk assets as the remaining indices should try and follow the direction of small caps into new highs.  The economy remains strong and the Fed is transparent in their approach to raising rates.  Couple this with muted sentiment the potential for a summer rally is real.  The wild card remains geopolitical affairs and the systemic risk from Italy but so far these events have been short lived and contained.