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Beware Stocks Worst Six Months

Market Summary

The Dow and S&P 500 have not hit new all-time highs since this time a year ago. The major indexes are still about 5% below these peaks. Many market pundits believe that there are no compelling reasons for stocks to hit new records anytime soon. Investors should prepare for daily triple digit price moves. "Investors had gotten used to a low volatility environment but they have been rudely awakened. This could be the beginning of a multi-year period of volatility," said David Jilek, chief investment strategist at Gateway Investment Advisers. The S&P is marginally positive for 2016. The S&P 500 eked out gains for the week after three straight weeks of losses, while the Nasdaq snapped a four-week losing streak. Despite gains on Friday, the Dow ended its fourth consecutive week in the red.

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. As highlighted in the chart below, the MTUM remains confined in a trading range established a few months ago. A false breakout a few weeks ago was not confirmed. Until there is a confirmed move out of the trading range momentum will probably remain stuck in neutral.

MTUM Daily Chart

It was reported how a measure of the dollar's strength against its main rivals hit a nearly one-month high last week after minutes from the Federal Reserve emphasized the possibility of an interest-rate increase as early as June. "It was puzzling to us that markets had become quiet complacent, not pricing in any possibility of a hike at the June meeting. So, clearly investors are now reassessing chances that the Fed might raise rates sooner than expected," said Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman. Treasury prices experienced their biggest weekly loss since November as traders sold off treasuries with a vengeance. Gold rebounded slightly from a six week lull but is still 4% lower than recent highs obtained back in late April above $1300 an ounce.

UUP Daily Chart

Market Outlook

"The markets are just treading water here. Normally markets rally on strong earnings and we've seen lackluster corporate earnings," said Stephen Kalayjian, chief market strategist of KnowVera. "A lot of companies are also talking about cost cutting and that usually means layoffs," he added. U. S. equities are at a critical juncture. May is the first month of the Worst Six Months for the stock market. Stocks made a brief high 4/20, then technical signals began to deteriorate. Weekly advancing issues on the NYSE have been falling the four weeks while declining issues have been on the rise and greater than advancers the past 2 weeks. New 52-week highs have expanded the past three weeks, but so have new lows, albeit not by much.

The Ned Davis definition of a bear market requires a peak to trough decline of 13% or more after 145 calendar days. The 364 days since the last all-time-closing high is an issue. History shows that similar gaps between market peaks tend to bode poorly for the stock market's direction. "The longer the S&P 500 goes without registering a new high, the more likely that it is a bear market," Michael O'Rourke, chief market strategist at Jones Trading in Greenwich, Connecticut said in a May 16 note to clients. Starting with the S&P 500 closing all-time highs since 1929, finds 13 previous times where S&P 500 spent more than 1-year before closing at a new all-time high. With the exception of 1994, there was always a bear market. Using a 20% decline, S&P 500 avoided a bear market just 3 times out of 13. In other words, there is a 76.9% chance that the current all-time-high dry spell will not end before there is a 20% or greater S&P 500 decline.

Quarterly Performance

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 05/18/2016. The most recent AAII survey showed 19.30% are Bullish and 34.10% Bearish, while 46.60% of investors polled have a Neutral outlook for the market for the next six months. The AAII survey points toward a continued 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 05/18/2016. First-quarter NAAIM exposure index averaged 45.89%. Last week the NAAIM exposure index was 49.55%, and the current week's exposure is 60.17%. As we commented recently "...As quarterly earnings season winds down money managers have become disillusioned with lackluster results and are using market up days to dump shares..."

NAAIJM Exposure Percent

Trading Strategy

The release of the FOMC minutes from the last meeting on April 27 suggested that a rate hike in June is quite possible. Inflation, retail sales, disposable income and the dollar index are on the rise in conjunction with a firm labor market. The Stock Barometer says the word June was used 8 times in the minutes in close proximity to the increased possibility of a rate increase, leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting. It also mentioned, Perhaps a surprise hike from the Fed in June might be the straw that will knock the market down. As we suggested last week, it is critical to honor stop-loss plans and don't be afraid to convert to a high cash position.

30-Day Performance

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