Looking back over the last 12 months, we can see the market has been working hard to get ready for this widely anticipated event next month. Selectivity has become very pronounced as seen through indices like the NYSE stock index down 2-3% since July of 2014. Last week there was a notable shift and one that we’re watching closely. It’s still too early to suggest that a new uptrend is upon us but there are some positive signs.
New Surge in Transportation and Utilities!
Transports and utilities have been two of the weakest spots in the market since the springtime. Dow Theorist point to this weakness as a traditional predictive guide for future corrections or bear markets in the broader market. We have pointed to this several times over the last 6 months. But as of late July, both have suddenly seen a surge in buying pressure, broken short term down trends and began outperforming even the mighty S&P 500! Dow theorists have got to be scratching their heads wondering if we’re getting ready for another broad market surge higher now. So what’s going on?
Strangely, transportation is one of the most economically sensitive sectors (cyclicals) out there and act as a canary for real economic activity. When no one is moving “stuff” (People, goods, raw materials) around the country or globe, it indicates economic activity is also slowing down. Global economic activity is slowing; we know this. So the surge is most likely a technical one based on a nearly historical wipe out in the energy sector driving down fuel costs and making transportation companies more profitable. Regardless, strength in transportation is a welcome sign.
The move higher in utilities may likewise be just technically driven mostly via new attractive valuations plus healthy dividend income. We do know that the Federal Reserve is going to raise SHORT TERM interest rates in September. But utilities are not subject to SHORT TERM interest rate risk as they borrow money only on very long term maturities. So, yes utilities are interest sensitive but only to long-term interest rates. Since late January, long-term bonds lost 14% to the lows on June 30th. Utilities also fell dramatically in sympathy by almost exactly the same amount (-14.6%). Utilities were simply adjusting to the trend of higher long-term rates and are now finding good support and buying interest at the more attractive levels. Furthermore, utilities are one of the favorite equity interest investments, as they tend to pay out higher dividends than the interest rate of even the best bonds out there. When there is value in utilities and bonds are paying historically low rates, they will find buyers looking for income.
Small Caps Ready to Run Again?
Also in the last week, we saw some new strength in small caps, which have been under heavy selling pressure for the last few months. Small caps are another one of those “Risk on/Risk off” asset groups indicating the mood of investors. On several of the hard down days in the last couple weeks, small caps have held up relatively well and are now slightly more attractive than more overbought large caps. Today, as I write, small caps are up over 1% while the S&P 500 is up barely .45%. Healthy leadership by small caps is always welcome to market bulls and this provides more evidence that the internal condition of the market is now improving. Keep in mind that small caps are not yet leading on an intermediate term basis, which is really one of the necessary ingredients before we see an improvement in our Net Exposure model. So we have improvement but not a confirmed change in the status of our Net Exposure screen.
Buyer in the Hole!
Last Tuesday was an ugly day in the morning but by the afternoon, buyers had come to the rescue to see a positive close to the day. The day formed a long “tail” which shows as a deep line on the bar chart below (marking the intraday lows with higher close). This was a critical test for the market, as a close at the lows would have sealed in a new very steep downtrend for the broad US market. On that day, we had quite a bit of money queued up for afternoon sells, as many of our positions would have broken stops. Thankfully, we didn’t have to exercise those trades and held on.
There is the chance that the market was just tipping its toe in to test the water before taking a more committed plunge and that risk still remains today. However, with the additional evidence as described above, I think the odds are good that the day represented more of an exhaustion of sellers rather than a test of lower levels. A strong finish to the week on Friday, gave market technicians more confidence. We’ll remain cautiously invested for now.
That’s it for the week – stay tuned and enjoy the last days of summer.