The Russell 2000 is a small cap index and it had been lagging for quite awhile....until 2016. This year the Russell 2000 is wildly outperforming the S&P 500 and now we're heading into December, its most bullish calendar month of the year by far. Since 1987, the Russell 2000 has produced annualized returns of 38.49% during the upcoming month and December has risen 25 times while declining just 4 times. Clearly, December is the sweet spot for small cap stocks. Here's a look at the relative strength of small caps vs. the benchmark S&P 500 ($RUT:$SPX):
The long term chart for the $CRB continues to be a worry for technicians like me trying to understand why Commodities are having trouble staying above the 45 year trend line. Oil reached lows around $10-$12 in the 2000 period whereas now the oil low was $25. Currently oil is at $46 and this long-term commodity chart is barely holding the long term trend. The question that needs to be asked is what is changing the long-term trend in commodities that suggests the historical support level is not longer support?
My October 6 market message suggested that the Japanese yen was peaking which would give a boost to export-oriented Japanese stocks which appeared to be bottoming. Since then, the yen has fallen to the lowest level in six months against the dollar, and has fallen below its 200-day average (Chart 1). At the same time, the lower box shows the Nikkei 225 Index rising to the highest level since January (based on today's higher close). But that's only part of the story. That earlier message explained that foreign investors (like Americans) buying Japanese stocks need to hedge out the negative effects of a falling yen. As explained at the time, the easiest way to do that is through the Wisdom Tree Japan Hedged Equity ETF (DXJ).
DXJ OUTPACES EWJ... As I've explain in the past, foreign stock ETFs traded here in the states are quoted in U.S. dollars. As a result, they tend to do worse when the dollar is rising against the local currency (like the yen). Since October 1, for example, Japan iShares (EWJ) have actually lost value (-1.5%) despite a nearly 10% gain in Japanese stocks. By comparison, the Wisdom Tree Japan Hedged Equity ETF (DXJ) has gained 10% over the same time span. The difference between the two Japanese stock ETFs is mainly an -8% drop in the yen. Chart 2 plots a ratio of the DXJ divided by the EWJ since the start of the year. The ratio started rising during October as the yen started to drop, and has risen to the highest level in nearly eight months (meaning the DXJ is doing much better than the EWJ). That's because the DXJ hedges out the negative effect of a falling yen. The same principle holds when investing in other foreign markets. This week's upside breakout in the dollar increases the need for hedging out the negative effect of falling foreign currencies when buying foreign stocks.
The market began its move to riskier assets in July and this move simply accelerated over the last two weeks. The chart below shows stocks (risk assets) bottoming in late June and Treasury bonds (safe-haven assets) peaking in early July. The S&P 500 SPDR (SPY) hit a new high this week and the 20+ YR T-Bond ETF (TLT) is trading at its lowest level since January. The indicator window shows the price relative (SPY:TLT ratio) bottoming in February, forming a higher low in early July and surging to its highest level since summer of 2015. This means stocks are outperforming T-bonds and this reflects a strong risk appetite in the US markets.
The Dow has shattered records, small- and mid-caps are doing the same. Those that have not yet reached record highs are still participating, preparing to break above all-time highs. Indicators for some time have been leaning bearish, but in the past week DecisionPoint indicators in the intermediate term have a new decidedly bullish bias.
The market has been in non-stop higher mode ever since the election. The NASDAQ is up over 6%. The Dow rose 1000 points in four trading days. The small cap Russell 2000 rose over 13%. At the same time, bond yields have soared with the ten year US Treasury Note up 60 basis points from its recent low. The US Dollar index climbed over 100, hitting its highest level in 13 years. What do all of these have in common? They are extremely stretched.
Let's take a look at the Russell 2000.
Just look at what small cap stocks have done since the November 3 bottom. The Russell 2000 has risen 13.5%. On top of that stochastics are now close to 100 with a RSI at 74. These are levels that almost always indicate a near term top is near.
Of course we all know the market, sectors and individual stocks can remain extended for a long period of time. But what happens is it gets harder to advance in any meaningful way and the reward to risk shifts to the downside.
Think about it. A 13.5% move in an index would be considered a great year, let alone two weeks. Tack on massively overbought technical indicators and it gets harder and harder to justify going long.
Interestingly, I studied 50 stocks in our "Candidate Tracker" which includes stocks on companies that beat earnings and have strong charts. In the vast majority of cases the stocks have performed very well since they reported their earnings and most of them are stretched, making them too tough to chase. On the other hand, if we remain patient I'm fairly confident many of them will pullback on any market correction, making them strong trading candidates.
That's where the patience comes in. If the market is stretched, bond yields are stretched and the US Dollar is stretched, it makes total sense to sit on your hands and wait for better opportunities. If you end up missing some upside, so what?
You might be interested in checking out some of the stocks in our Candidate Tracker so you can see for yourself how stocks with strong earnings have performed. Just click here.
One final thing. Just prior to the election fear had escalated big time with the Volatility Index (VIX) touching 23. Since then fear has evaporated, with the VIX close to 13. What does this tell me? That traders wanted nothing to do with the market when it had pulled back sharply prior to the election and now they can't get enough of stocks just when it might be primed for a breather. Classic!
At your service,
The "under the surface" signals have been quite bearish for the past 1-2 years. Money has rotated away from aggressive areas and I've discussed it here and my Trading Places blog quite often. But it was very difficult to think bearish thoughts as long as the combination of price and volume remained bullish. So I've been waiting to get the bearish price breakdown before re-evaluating the market. That breakdown came last week during one of the most historically bullish periods of the year - strange indeed. Let's look first at the warning signs and price breakdowns prior to both the 2000-2002 and 2007-2009 bear markets:
LIFE INSURERS LEAD FINANCIALS HIGHER ... Rising bond yields continue to give a boost to financial stocks like life insurers. Bear in mind that premium income in insurance stocks is invested mostly in fixed income markets. Higher bond yields mean higher income. Life insurers are leading the financial sector higher today. Several of the big life insurers are seeing nice gains after beating earnings estimates. Chart 1 shows the Dow Jones US Life Insurance Index ($DJUSIL) climbing more than 2% today and nearing a new 2016 high. The index is in a clear uptrend, as is its relative strength ratio (top of chart). Several individual stocks are already hitting new highs.
RISING RATES ARE WEIGHING ON STOCKS IN GENERAL ... There's good and bad news in the prospect for higher bond yields. The good news is that it favors financial stocks. To the extent that rising rates are also hinting at higher inflation, it may also be good for commodity related stocks like energy and materials. The bad news is that rising rates are bad for dividend payers, and possibly even consumer discretionary stocks that are hurt by rising consumer prices. Which helps explain why stocks have been basically flat since midyear. More groups have been falling than rising. Since midyear, only three sectors are in the black: technology (+8%), financials (+6%), and industrials (+2%). Energy and materials are basically flat. All the rest are in the red. That's three up, two unchanged, and seven down (counting telecom). Combined losses in the four dividend paying groups (and healthcare) are bigger than gains in financials and technology (with tech turning down this month). That makes for a flat market with a downside bias. For the market to make any upward progress, either the more economically stocks need to strengthen and/or the dividend payers need to stop falling. That leads to a couple of possible conclusions. First, the net effect of rising bond yields has been negative for major stock indexes. That calls for a more cautious stance. Beneath the surface, however, money is rotating into stocks that should benefit from rising yields and higher inflation. That may offer a way to take advantage of the current situation. Chart 2 shows rising relative strength lines for stock ETFs tied to energy (red) materials (blue), and financials (green). Traders are also buying put insurance (volatility) to hedge against possible stock losses.
The S&P 500 SPDR (SPY) and the Russell 2000 iShares (IWM) both broke below their September lows with IWM leading the way lower. QQQ is still holding up the best because it hit a 52-week high the week before and remains above the September low. Looking at SPY first, the ETF fell around 5% from high to low over the last eleven weeks. This modest decline comes after a 22% advance from the February lows and a 10% advance from the late June low. Even though the inability to hold the breakout is negative, I still view this as a correction within a bigger uptrend. The blue trend lines mark a possible falling channel to define this correction and I am marking resistance at 215.50.
If you look at the DP Scoreboards by themselves, you would note that the NDX appears to have internal strength given that two July BUY signals are still intact in the intermediate term. However, a look at the charts reveals those signals are about to break.