The stock market finished the day yesterday nicely in positive territory and the futures are trading higher this morning…so everything seems right with the world. The problem is that the “internals” in the market have not been very good in recent days. This is important because it’s the the exact opposite situation from what we saw about a week ago at this time…when we sent out a midday note highlighting that the much better “internals” were telling us that the market would rally a lot further…..Instead of good volume and exceptional breadth, we’re seeing just the opposite. For example, volume was once again ridiculously low at just 2.6bn shares yesterday…and the breadth (advancers/decliners) was feeble. It was only 1.6 to 1 positive for the S&P 500 and just 1.4 to 1 positive on the NYSE Composite volume. Those are lousy numbers for a market that was up one half of one percent. (It was 1.6 to 1 positive for the Nasdaq Composite…which rallied a full 1%! That stinks.)
We’d also note that even though the S&P closed well within positive territory yesterday, it rolled over in the afternoon…and gave back about 2/3 of its midday gains. So that’s not a great sign. On top of this, we’d point out although the S&P has retraced 75% of its May decline, the cumulative A/D line has only retraced 50%. So even though we’re seeing more stocks hitting new 52 week highs, this bounce is not as broad as you would usually see when a rally is going to have legs.
So there is no question that our very positive short-term stance on the market has now changed…after the 5% rally over the past week. Of course, just because we’ve been spot-on over the past six weeks or so, it does not mean we’re correct about turning more cautious right now. However, we believe that the one thing we need remember is that basically nothing has changed on the trade front with China over the past week…and THIS is the most important issue facing the markets right now. Everything is still in limbo on the trade front.
In other words, trade/tariff concerns with Mexico were completely non-existent throughout 98% of the decline the stock market experienced in May. It is now non-existent once again. It was simply a situation where the President fixed a problem that he himself created (and a problem that did not exist before the last day or two of May). So when it comes to the issue of trade, we’re really no better off than we were in late May…and all of the uncertainties that existed back then are still with us today.
HOWEVER, this does NOT mean that nothing has changed at all in the market place! The Fed’s “jawboning” HAS shifted to a more dovish stance. Therefore, since nothing has really changed on the trade front, the stock market bulls are now pinning their hopes on the Fed…and their willingness to get into the insurance business…and give us a “pre-emptive” rate cut. (Maybe they’ll hire the Caveman, the Gecko, the Little Piggy or Flo to help them sell this story. Let’s fact it, if one of those actors can do half of what they did for Geico & Progressive Insurance, the Fed will be able to get out of the “jawboning” business altogether!!!)
All kidding aside, we still believe it would be a big mistake if the Fed engaged in that kind of strategy…where they give the markets an “insurance rate-cut”. In fact, we think it would be irresponsible. It will only create a situation where investors could COMPLETELY throw all caution to the wind. That, in turn, would be great for the markets over the near-term…as it would create another bubble. However, that would be the absolute last thing we need right now…given how much leverage there is in the financial system to day (especially in the corporate debt sector)………There’s nothing wrong with a pre-emptive move before the economy turns down too severely, but it’s another thing to do it before the markets experience much stress. (Today’s markets are a lot different than they were in 1995…as the leverage in the system is much, much higher now.)
Of course, just because the Fed shouldn’t engage in a pre-emptive rate cut too early, it does not mean they won’t. Therefore, we are going to have to stay nimble. However, it is our belief that since the history of the past 10 years tells us the Fed does not “act” until the stock markets see a lot more stress than they’ve seen thus far…and because the trade issue with China has not changed at all yet…this rally will not last much longer. Thus we believe that we’ll see lower-lows in the stock market before the Fed comes to the rescue. (We use the “history of the past 10 years” because that’s when the Fed’s actions have become SO much more important to the direction of the markets than it had been in the past.)
Let’s shift gears and look at the healthcare stocks…which look quite good right here. Politics are obviously playing a key roll in today’s markets…and one would think that this would be negative for the healthcare stocks. The drug pricing issue is one that both sides can agree there are problems…so you’d think this issue would raise its head at some point between now and the 2020 election (much like it did in the last Presidential election cycle). However, the group actually acts quite well. The XLV healthcare ETF did not decline as much as the broad market during May…falling about half as much as the S&P 500. We’d also note that this ETF has now broken out of a “symmetrical triangle” pattern…so that is bullish. However, we DO need to point out that the break is only a slight one so far, thus we’ll need to see more upside follow-through to confirm its break-out. In fact, we’d point to the 93 level as the one we’ll be watching. That is the March highs, so if the XLV can move above that level…and give it its first “higher-high” since February...it would lead us to become quite bullish on the sector. Therefore, despite our concerns that the healthcare group cold face some possible future headwinds, it’s looking quite good near-term…at least on a technical basis.