Pullbacks Do Not Always Come When Crowd Expects
Markets must climb a wall of worry. The long-time expression on the Street
is backed by common sense. If investors are worried, then it stands to reason
that they may have kept some money on the sidelines for the pullback they "know" is
coming soon. Conversely, if investors were theoretically 100% confident that
stocks would push higher, then everyone would be fully invested. Worry means
cash is available to provide buying power. 100% confidence means buying power
is limited.
Doubters Could Be Swayed By Money Printing
If you have cash on hand because you are expecting a pullback, what might
cause a change of heart? One powerful source of motivation in the markets is
the fear of missing out. The Fed persuaded some "wall of worriers" to redeploy
cash Monday after making market-friendly statements. From Bloomberg:
Three Federal Reserve officials who vote on policy this year signaled
the Fed may press on with easing for some time to reduce the jobless rate
and push up inflation toward the central bank's 2 percent target. "Monetary
policy in the United States is likely to remain highly accommodative for
some time," Fed Governor Jerome Powell said yesterday in a speech in San
Francisco. Boston Fed President Eric Rosengren backed further easing to "achieve
full employment within a reasonable forecast horizon," while James Bullard
of the St. Louis Fed said in an interview on CNBC he wants the Fed to "meet
our goals," singling out inflation.
Improvement Was There For All To See
Clear and observable improvement in weekly trends began when the stock market
found a bottom on October 9. Our market
model, which uses binary and unbiased inputs, picked up on the change in
investors' tolerance for risk on October 10, necessitating some changes to
our investment allocations.
Twitter Provides Sentiment Gauge
There is a reason traders who focus on price are successful. Price captures
the aggregate opinion of all market participants about future economic outcomes,
earnings, valuations, systemic risk, monetary policy, the Fed, etc. Technical
analysis (TA) is the study of charts. Charts provide a vehicle to monitor price
or what "is happening", rather than what "we think will happen" or "what we
want to happen". The power of charts, and why they are used by the vast majority
of pension funds, is they allow us to monitor the mechanism that sets asset
prices. If you understand how
assets prices are set, then the value of monitoring charts is easy to understand.
The table below shows the technical health of the weekly battle between bullish
economic conviction and bearish economic conviction, which is what determines
the value of our investments. The table summarizes visible evidence from charts.
The 99% next to the S&P 500 ($SPX) means that 99% of the binary questions,
relative to the weekly trend, returned "bullish" answers and 1% came back with
a "bearish" response. Save the "it shows an overbought market" comments for
another time; markets can advance for weeks or months with scores similar to
the ones in the table below.
Despite the clear evidence of improvement since the October 9 low in stocks,
the chatter on Twitter over the past four weeks has been sprinkled with doubt.
Tweets about non-confirmations, divergences, short positions, rising wedges,
and broadening tops have been easy to find as the S&P 500 tacked on over
100 points. That fits the profile of a wall of worry.
Cracks Could Fuel Pullback In Stocks
Is everything rosy when examining the battle between bullish economic conviction
and bearish economic fear? No, some cracks have started to form over the past
two weeks. The table below shows observable weakness in the credit markets
(JNK vs. TLT), small caps (IWM), and financials (XLF). The green and orange
tables are explained in more detail in this November 2 video
segment.
Wonder Twin Powers Activate
As the little kids say on the AT&T commercials "more is better". The waiting
for a pullback crowd is also getting a little nervous about a dual money printing
threat as the Fed and European Central Bank continue to hint at accommodative
policy. From Reuters:
European shares touched a fresh five-year high and the euro dipped on
Tuesday with speculation mounting that the European Central Bank will signal
an easing of monetary conditions at its policy meeting this week. The likelihood
of looser policy from the ECB comes as markets increasingly price in the
prospect of the U.S. Federal Reserve maintaining its huge equity and commodity
friendly stimulus into next year. Public comments by Fed officials on Monday
stressed that the U.S. central bank was in no hurry to taper its asset
purchases and would only begin when the U.S. economy showed clear signs
of improvement.
To stay on the ECB's low interest rate page, a European Union official recently
called for diligence on the easy money front. From Bloomberg:
"We are seeing clear signs of an economic turnaround, but growth will
pick up only gradually and will translate into jobs only with a lag," EU
Economic and Monetary Affairs Commissioner Olli Rehn told reporters in
Brussels. "We must not fall into the trap of complacency. Further decisive
action to boost sustainable growth and job creation will continue to be
necessary in Europe."
Market Breadth Quietly Improving
If you follow the markets closely, you know when the term taper burst onto
the scene in late May, the tone of the markets changed significantly. The chart
below shows the percentage of NYSE stocks above their 200-day moving average.
The 200-day is used by traders to monitor longer-term trends. Healthy markets
tend to have broad participation. The chart below is one way to monitor participation
or market breadth. Market breadth was clearly in a bearish downtrend over the
summer (see orange arrows). Three
steps are required for a bullish change in trend; all three have been completed,
which signals a change in the market's bias.
Investment Implications - Pullbackers May Be Disappointed
Markets rarely fulfill the hopes and desires of the masses. The trading crowd
still seems to be hungry for bearish evidence. Bullish evidence has been keeping
company with crickets. While the previous statements are anecdotal, they align
with the wall of worry theory of cash levels and buying power. The orange-filled
table presented earlier tells us to respect the possibility of a pullback in
stocks. However, those who have missed the sharp rally off the October 9 low
may be quick to redeploy their cash with central banks ramping up the easy
money rhetoric.
If weakness is in the probability cards, the blue trendlines (A and B) may
attract buyers near 1760 or 1750 on the S&P 500. If 1750 fails to hold,
horizontal support, based on key levels in September and October fall between
1733 and 1721 (see pink lines C, D, E, and F).
Our game plan, given what we know today, is to exercise patience during any
corrective activity in stocks, but we are open to making adjustments based
on the observable evidence if necessary. We continue to hold positions in the
United States (VTI), Europe (EFA), and emerging markets (EEM).
