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Why Stocks Should Grind Higher

Market Summary

Equites have recovered from the sharp early-year selloff and as seen in the chart below, most of the stock indexes are finally in the black year-to-date. Still the market is 2.5% below its May 2015 high. For the week, the S&P 500 Index gained 1.6% while the Blue Chip-heavy Dow Jones Industrial Average rose a solid 1.8%. The Nasdaq was up 1.5% while the small cap Russell 2000 led gains the major indices finishing up 3% for the week.

YTD Performance

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. Last week's analysis is still valid where we said, "...the market is moving higher on weak momentum. This indicates that buyers may be getting exhausted...the weak uptrend has converted into a trading range...momentum starting to turn negative which should help resolve the overbought condition. Expect MTUM to break out of the trading range to the upside if the longer-term uptrend remains intact..."

MTUM Daily Chart

Recent analysis stated, "...We like to compare the DOW Industrials and Transports to confirm the current market trend...unless both indexes converge higher, it will be difficult for the DOW Industrials to continue going up..." As seen in the updated chart below, DOW Industrial and Transports have converged higher, which is considered a strong sign the market should continue an upward grind.

Dow and Transports Daily Charts

The dollar moved higher last week on mixed economic data. After two consecutive weeks of gains, treasury bonds fell last week as investors are selling bonds to fuel the equity market rally. Gold also dropped in response to the strengthening dollar.

US Dollar Index, T-Bonds and Gold Daily Charts

Market Outlook

The U.S. earnings recession that began in the third quarter of 2015 is expected to continue until the second quarter, with profits slated to fall 2.2%, not as bad as the nearly 8% drop expected in the first quarter. The first quarter, should it come in as expected, would mark a third straight quarterly decline in earnings and a fifth straight fall in revenue. Going forward, year-over-year comparisons should improve, said Richard Bernstein, chief executive and chief investment officer at Richard Bernstein Advisors in New York. A turnaround in profits would blunt one of investors' biggest worries, an ongoing weak earnings cycle. There are plenty of global economic concerns keeping investors subdued at this point. Worrying some investors is how cash flow has declined for S&P 500 companies in the past year, making it harder for them to buy back shares. Buybacks help boost earnings numbers on a per-share basis. The chart below displays the recovery from the market bottom in February for major asset classes. Notice how investors are aggressively buying riskier equity assets as the Fed has backed off raising interest rates. Many investors believe a rate increase would slow the economic recovery.

Performance since February 11

The CBOE Volatility Index (VIX) is known as the market's "fear gauge" because it tracks the expected volatility priced into short-term S&P 500 Index options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends the VIX higher. The VIX has stabilized at the support level established in November, denoted by the orange dotted line in the chart below. Buying the VIX is cheap insurance at this price to protect against a market pullback.

VIX Daily Chart

The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. The current survey result is for the week ending 04/13/2016. The most recent AAII survey showed 27.80% are Bullish and 24.90% Bearish, while 47.30% of investors polled have a Neutral outlook for the market for the next six months. We said last week "...the current AAII survey, retail investors remain definitively neutral about the near-term market direction. Historically low Bullish and Bearish sentiment suggest continued range-bound trading..." The current AAII survey continues to signal a near-term neutral trend.

AAII Sentiment

The National Association of Active Investment Managers (NAAIM) Exposure Index represents the average exposure to US Equity markets reported by NAAIM members. The blue bars depict a two-week moving average of the NAAIM managers' responses. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks. The current survey result is for the week ending 04/13/2016. First-quarter NAAIM exposure index averaged 45.89%. Last week the NAAIM exposure index was 73.21%, and the current week's exposure is 63.97%. Quarterly earnings season shifts into high gear next week. Investors probably need to hear strong financial results and future guidance to keep equity exposure above the current level.

NAAIM Exposure Percent

Trading Strategy

As earnings season shifts into high gear next week in what is expected to be the weakest U.S. quarterly results reporting period since 2009, the hope among some pundits is that results might not be that bad. Richard Bernstein, chief executive and chief investment officer at Richard Bernstein Advisors thinks the low point of the profit downturn may have been at the end of last year, based on trailing four-quarter data. He is overweight sectors he considers sensitive to the profit cycle - energy, materials, financials and technology. Last week, we mentioned how the Stock Trader's Almanac reported the bullish bias of last week's April expiration also persists during the week after. DJIA has posted a full-week gain in ten of the last twelve weeks following expiration. Historically April is usually a positive month for the market. The S&P 500 has been positive in April 70% of the time since 1945, and in the past 10 years, April has been the top-performing month. What is considered higher-risk sectors are displayed on the left side of the graph below. You can see that along with Healthcare the riskier categories like Materials and Industrials are the top performers over the past month. Traders are trading "risk-on" and using spread strategies to execute these types of trades, which mitigates the inherent risk involved.

30-Day Performance of S&P500 Sector ETFs

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