THE BOTTOM LINE
The NASDAQ and S&P-500 have now made new all-time highs, which suggests a new bull market began at the March 23 low. However, the index has arrived at new highs showing evidence of fatigue, which may suggest a correction may be needed to re-invigorate demand, or that the rally may be the terminal movement in the long economic recovery, and coincident longest running stock market rally in history. A significant correction resulting in a higher low may be required to confirm the former, and the breaking a series of important support levels confirmed by weakness in an array of supply and demand indicators may be required to confirm the latter. In either case volatility is likely to rise, which suggests a strategy of deploying intermediate term tactical trades may reduce the implied risks of buy and hold on the potential cusp of reversals in a number of key global markets like precious metals, currencies, interest rates (bonds), and finally stocks. And, here on the cusp of the historically seasonally weak months of September and October, what better time for these reversals to commence.
If the current rally is the caboose in the long running recovery rally dating to the 2007-2009 economic crisis, which will yield to a large degree bear market, or is just a fatigued first leg up in a new secular bull market, a correction would appear needed to re-invigorate evidence of slackening demand. The resolution of this potentially dangerous conundrum will depend on the depth and duration of any subsequent correction. In the interim tactical trading to take advantage of opportunities to enhance performance, and reduce exposure to risks, may become the necessary order of the day.
SIGNS OF FATIGUE APPEAR
A significant portion of the massive infusion of liquidity into the economic system compliments of the Administration, the Congress, and the Fed has been finding its way its way into the stock market, and in the process has floated prices of the NASDAQ and S&P-500 to new all-time highs in the face of multiple negative factors, and huge global uncertainties. In more normal times any one of these unprecedented uncertainties would have likely triggered a significant correction, or outright bear market. Even so, the bid under the market has remained relentless for weeks, as every attempt by the impotent bears to gain control during modest pullbacks has been met with vigorous bidding, especially in a handful of big cap (Tech) stocks, which dominate the capitalization weighted indexes.
Record highs have been touched almost daily in the NASDAQ, and this past week the S&P-500 joined the NASDAQ at new all-time highs, albeit only marginally, and not without a stumbling struggle, which makes one wonder if much effort has been expended, and lots of liquidity absorbed for only marginal results. In fact the rally to new all-time highs post August 10 was attained as evidence of fading demand was growing, which has now been confirmed by weakness in the advance/decline line, and the up versus down volume numbers. And, did I mention the continuing high bullish sentiment numbers, which in Contrarian Market Theory means there are too many investors on the same side of the market. And, one leading market letter this past week noted that professional investors are 101% net long the market, which means many are buying stocks on margin, or using derivative type leverage to boost the power of their cash to buy more shares. These kinds of extreme bullish measurements have a long history of appearing near significant tops.
The new all-time highs in the NASDAQ and S&P-500 have now nullified the bear market recovery rally case, which for a host of reasons has been the more probable case, even though weeks ago we alerted clients that one of the ways this may resolve was for the March 23 low to turn out to be bottom of the last leg of a correction dating to 2018, and not a kick off leg in a new bull market. One plays the investment game by making decisions in line with the most favorable probabilities, but as this post March 23 rally has now demonstrated probabilities are not certainties.
However, our preservation of capital strategy may yet prove to have been prudent, as this bull leg off the March 23 low has arrived at marginal new all-time highs basis the S&P-500 looking exhausted, over-valued, over-extended, over-bought, and possibly vulnerable to buyer’s fatigue given the concentration of most of the buying in just a few big cap names, AAPL comes to mind. AAPL, one tech stock, and admittedly a great company, now has a market value approaching the total value of the Russell 2000 index! According to Bloomberg AAPL has a forward P/E of 38.59, a price-to-book ratio of 29.48, and it’s price-to-sales ratio is 8.0, not exactly a Graham and Dodd value stock!
Diagnosing significant tops, and reacting before the follow on bear market can do significant damage is one of the most daunting challenges in investing. I’ve spent years applying Lowry Research in real portfolios with real money, and Lowry is one of the very few research outfits out there, which have actually done fact based research on how tops have formed going all the way back to 1925. The late Paul Desmond (President of Lowry Research) obtained raw Dow data, and then spent years scrubbing it for errors back to 1925, and then re-populated the data into Lowry Research analysis format. Desmond discovered significant tops form when members of an index peel away one by one into their individual bear markets, while an ever fewer number of big cap stocks attract the last gasp residual demand. According to a clip on the CNBC phone app, while the S&P-500 touched a new all-time high this past week 62% of stocks in the index remain below where they were on February 19, the day of the previous all-time high (unfortunately no link is available for the clip).
This topping process results in a cap weighted index touching new highs giving the appearance of a healthy bull market, even as more and more stocks fail to participate in the rally, and many actually enter bear trends. Paul Desmond determined that this process has occurred at every major top since 1925, although two bear markets did start with the advance/decline line touching highs. So, here are some numbers from a service I use, which got my attention, and reminded me of Paul Desmond’s observation about stocks peeling away into their own bear markets prior to the final top in a popular index. In June 68.8% of S&P-500 stocks were above their 200 day moving average. That percentage has now dropped to 59.8%. The S&P-500 made a new high today, but 56% of the issues closed down on the day, while the advancing volume was only 33.6%, and declining volume was 66.4%.
The NASDAQ touched a new all-time high today while just 29% of NASDAQ stocks advanced on the day, the lowest percentage in history back to 1984. Yes the NASDAQ and S&P-500 are making new all-time highs as you have likely heard on the evening news, but what the news probably did not say is only a few stocks are currently driving the cap weighted indexes higher, while more and more are weakening, and contributing to numbers showing diminished demand. This is objective information that the stock market has arrived at new all-time highs showing signs of fatigue.
The current conundrum is whether a new secular bull market began at the March 23 low, and the first leg up in this new bull needs a correction to re-invigorate slackening demand, or if the post March 23 rally is the last leg up in the previously longest running economic recovery, and bull market in history.
TATY — A REPRESENTATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown above in Snapshot-368 in yellow with the S&P-500 overlaid in red and blue candle chart format. TATY closed the week at 131, and still displaying a negative divergence with the new all-time high price, shown on the chart as a bold down sloping magenta line.
TATY has a long history of accuracy, and has never lied to me. However, it’s atypical and abnormal behavior since the plunge to the March low began on February 12 in the Dow, and February 19 in the S&P-500, has been a huge puzzle. Now I am not naïve enough to believe any indicator will always be accurate, that just does not happen in this game of probabilities. However, given the statistically valid long sample size for TATY, it’s continuing atypical and abnormal behavior is certainly sending a message, which may be an important warning.
The NASDAQ and the S&P-500 have achieved new all-time highs, so why isn’t TATY bumping the 160 level shown by the light blue line on the chart. During bull markets TATY struggles to decline below the red zone surrounding the 140 level, and on the impulsive movements higher it tends to assault the 160 level, which is objective evidence of strong demand and weak supply in the balance of supply and demand for stocks. As tops begin to form TATY often negatively diverges with the still climbing price, a tip off to an astute analyst that supply is growing and demand is fading. Take a look at the chart above in the weeks before the February high and notice that TATY had already been declining.
Presently there is a yawning divergence between the new all-time high in the S&P-500 and TATY, which normally leads the price, both up and down. Is this suggesting that the current rally is the caboose in the long economic recovery, and coincident long running bull market, or is it just suggesting some fatigue in this supposed first leg up in a brand new secular bull market, which may last for years? I like the odds on the former, and not so much on the ladder. Why?
A mentor of mine still writes a well known market letter, which currently is forecasting a turn for the worst in the precious metals, a turn higher in the dollar (think trends in reverse of domestic interest rates), a rise in interest rates, and the emergence of a huge bear market in stocks. Now I do not know if any of things will come to pass as metals, currencies and bonds are not markets where I have developed effective indicators, which I trust. However, with regard to stocks TATY is suggesting something big, atypical and abnormal may be afoot, and it does not bode well for stocks. Like I’ve said before, no indicator is perfect in this business, but given that TATY accounts for not only shifts in NYSE driven data, but also has modules to account for the contribution to the balance of supply and demand for derivatives, TATY is suggesting that in spite of the new highs not all is well with the stock market. It would take TATY assaulting the 160 level to erase this concern, when it is struggling just to attain the red zone beginning at the 140 level.
Please stay safe!
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