Balloons, confetti, noisemakers, etc......No, we’re not talking about the Democratic National Convention. We talking about how the S&P 500 finally closed above the February closing highs yesterday...after bumping up against that level for over a week! Of course, there is also the risk that this move ends up becoming the kind of “double-top” we experience in 2000 and 2007, but with the Fed ready and willing to do “whatever it takes,” it’s hard to think that we’ll see another 50% decline...like we saw on those other two occasions.
That said, the Fed’s loaded bazooka does not preclude the market from seeing a short-term pull-back or even a correction, so investors will want to avoid becoming overly complacent as we move through the rest of the 3rd quarter. In fact, the stock market has seen short-term pull-backs once it reaches new record highs many times in the past...even if it is only one that gives back 3%-5%. So we’ll see what happens as we move through the rest of the week.
One of the reasons we’ve been calling for a short-term pull-back recently has been the way the most recent rally in the market has been even MORE NARROW over the past week or two than it was over the previous months. In fact, the new record high on the S&P yesterday came on very poor “internals”...ones that were even more disappointing than other days over the past week. The breadth on the S&P 500 was actually almost 2 to 1 negative! It was a bit worse on the NYSE Composite index (at 2.4 to 1 negative)....and it was flat for the NDX Nasdaq 100 index, even though that index rallied 1%!!!!.....On top of all this, the S&P 500 Equal Weight Index still remains more than 6% below its February highs. (In fact, it’s still 1.6% below its June highs!) Therefore, there is no question that this rally is about as narrow as you can get.
We always hear reasons why “it’s different this time” when the market rallies in a “narrow” fashion...and these arguments can seem especially compelling when the stock market is rallying on an almost daily basis. However history tells us that narrow rallies are not healthy ones and end in pull-backs that are more than just mild ones.
It’s always hard to know what the catalyst might be to cause this rally to reverse itself. Problems with the fiscal plan...a break-down in the mega-cap tech stocks...and more problems with U.S./China relations...have been at the top of our list as candidates for a catalyst. However yesterday, we highlighted another issue...and we’d like to reiterate that issue again this morning because the situation has become even more extreme after yesterday’s action.
We’re talking about the decline in the dollar...and our belief that it has become incredibly ripe for a “tradable” bounce (one that lasts for at least several weeks). As we highlighted in our piece yesterday, the reasons we have for believing the greenback will bounce in a meaningful manner soon have nothing to do with the fundamental outlook for the dollar. There are still many reasons to think that the dollar will decline once again later this year, but when everybody moves to one side of the boat (which is the case for the dollar right now...and the euro on the other side of the boat), it leaves it VERY vulnerable to a multi-week (or even multi-month) reversal...no matter what the longer-term fundamental outlook might be...and even if it resumes its recent decline after the “tradable” reversal.
As we highlighted yesterday morning, the weekly RSI chart for the DXY dollar index was becoming as oversold as it was at the bottoms for the dollar is both 2017 and 2018. Those oversold readings were followed by bounces in the dollar that lasted two months in 2017 and four months in 2018. We also highlighted the Commitment of Traders (COT) data...which showed a very large net short position in the dollar for hedge funds (the highest in two years)...and record net long position in the euro for the dumb money “specs”! In other words, the short dollar/long euro trades have become VERY crowded recently.....On top of this, the DSI data shows that the percentage of futures traders who are bullish on the dollar fell to only 9% after today’s action (and it’s 92% bullishness for the euro). You don’t see sentiment get this extreme on any asset very often at all, so you can see that the dollar has become extremely over-hated (and the euro has become extremely over-loved).
Again, this tells us that there are too many people on one side of the boat in the currency markets. Therefore, no matter what the longer-term fundamentals are telling us about where the dollar is going to go by the end of the year and beyond, it should be headed higher over the next few weeks. That should be bearish for several different asset classes...and including the stock market.
We readily admit that there have been plenty of examples in the past when the stock market rallied at the same time the dollar was bouncing, but the correlation with commodities and emerging markets (which is an inverse correlation) is very, very strong one. Therefore, traders need to be VERY careful about buying commodities and EM’s on a short-term basis. In fact, those short-term players should consider taking some profits in these asset classes. As for longer-term investors, they should avoid chasing these asset classes...and look to buy them at lower levels down the road...after they pull-back in reaction to a rally in the dollar.
On top of our call for a tradable bounce in the dollar, we’d note that both the CRB commodity Index and the EEM emerging market ETF are getting quite overbought, so they were getting ripe for a pull-back on a technical basis anyway. For instance, the daily RSI chart on the CRB is getting extended...and this is taking place at a time when the CRB is testing its 200 DMA. Therefore, this would be a perfect place for commodities to see a pull-back...even if they are headed higher over the longer-term.......Similarly, the weekly RSI chart on the EEM is reaching a level that has been followed by pull-backs over the past several years, so it is getting ripe for (at least) a breather as well.
We are definitely bullish on these asset classes over the longer-term...and ESPECIALLY bullish on commodities. However, we’ve done this long enough to know that even when an asset class is seeing a major change in its long-term trend (like the commodity markets are), it does not happen in a straight line. When too many people move to one side of the boat, short-term reversals can and do take place...and when we say, “short-term,” we’re talking about “tradable” reversals...not just ones that last for 2-3 days. We believe that this is what we’re seeing right now in the currency markets, so we STRONGLY believe that investors should look for a bit of a change in the movement in the currency, commodity and emerging markets over the coming weeks.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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