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Are Stocks Primed to Breakout?

Market Summary

Market indexes posted sizable weekly and quarterly gains. Last week, the benchmark S&P 500 index gained .8% and the blue-chip DOW Jones Industrial Average rose .2%. 7%. The tech-heavy Nasdaq Composite Index logged a 1.4% weekly gain and returned a nearly 10% gain over the past quarter, its best quarterly performance since the end of 2013, according to FactSet. The smaller cap Russell 2000 and MidCap 400 indexes are the biggest winners ending higher 2.31% and 1.49% respectively. As seen in the chart below, since the presidential election the major stock indexes moved higher but have been trending sideways the past six weeks. Conversely precious metals and treasury bonds had suffered under the threat of higher interest rates, but are starting to recover the past few weeks as the dollar has waned.

Performance since Nov 8

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 overall 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 we said, "... given the recent behavior of the stock market, now the question appears to be whether the price trend will continue to move sideways or start turning down..." The response to this question is the trend continued moving sideways. The MTUM trading range is highlighted in the updated chart below. Now the question is will the price trend remain neutral or finally break through the top of the trading range? With the market leader Nasdaq Composite setting new all-time highs and earnings season starting up, the MTUM might be primed for a breakout which signals the next bull leg for the major indexes.

MTUM Daily Chart

A tool to help confirm the overall market trend is the Bullish Percent Index (BPI). The Bullish Index is a popular market "breadth" indicator used to gauge the internal strength/weakness of the market. Like many of the technical market internal indicators, it is used both to confirm a move in the market and as a non-confirmation and therefore divergence indication. Nasdaq stocks have been leading the market direction for the past year. Recently we opined "...Until the BPCOMPQ recovers we don't expect the equity market to start accelerating to new highs again..." Circled in the chart below you can see the BPCOMPQ is beginning a recovery bounce. In fact last week the Nasdaq Composite Index posted a record closing price. If the index follows up on its recovery bounce and continues higher, this might be a very strong signal that the other major indexes are set to break higher out of their recent trading ranges.

NASDAQ Composite Bullish Percent Index

In the chart below, the dollar posted its first weekly gain since early March. "The focus is back on the dollar, can it retrieve some of the momentum it had immediately after the election? That very much depends on [President Donald] Trump," said Jane Foley, senior currency strategist at Rabobank. "He's had difficulty pulling the Republican Party together on legislation. Gold basically broke even for the week and the month of March. The good news is the gold notched its eighth first quarter gain of the last 10 years as the dollar faltered. Treasury prices jumped on Friday after New York Federal Reserve Bank President William Dudley said expectations for two more rate rises in 2017 weren't out of line. But overall treasury bonds are under pressure as other Fed officials remain hawkish about a rate hike.

US Dollar, T-Bonds and Gold Daily Charts

Market Outlook

Jeff Hirsch in the Almanac Trader talks about how April marks the end of what is historically the best six months for DJIA and the S&P 500. April 1999 was the first month to gain 1000 DJIA points. However, from 2000 to 2005, "Tax" month was hit, declining in four of six years. Since 2006, April has been up eleven years in a row with an average gain of 2.6% to reclaim its position as the best DJIA month since 1950. April is second best for S&P and fourth best for NASDAQ (since 1971). Typical post-election blues have done little to damper April's performance since 1953. April is DJIA's second best month in post-election years, gaining 1.9% on average. April is fourth best for S&P 500 and NASDAQ. Although post-election year 2005 did suffer a 3% DJIA decline. You can see in the quarterly chart below how the market leader Nasdaq stocks has taken over as the best performer reaching all-time highs last week. The Nasdaq has led the overall market up and down for over a year and the move higher should be expected to positively impact the other equity indexes heading into quarterly earnings season.

YTD Performance

Put/Call Ratio is the ratio of trading volume of put options to call options. The Put/Call Ratio has long been viewed as an indicator of investor sentiment in the markets. Times where the number of traded call options outpaces the number of traded put options would signal a bullish sentiment, and vice versa. Technical traders have used the Put/Call Ratio for years as an indicator of the market. Most importantly, changes or swings in the ratio are seen as instances of great importance as this is commonly viewed as a change in the tide of overall market sentiment. Investors have turned pessimistic ahead of the upcoming quarterly earnings season. Traders are aggressively buying put contracts as insurance to protect against lower stock prices.

Put/Call Ratios

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 03/29/2017. Pessimism bounces back after two weeks of declining, while neutral and bullish sentiment declined compared to last week. Bullish sentiment, expectations that stock prices will rise over the next six months, fell 5.1 percentage points to 30.2%. The historical average is 38.5%. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 1.8 percentage points to 32.4%. Despite the weekly decline, neutral sentiment remains above its historical average of 31.0% for the second consecutive week. Bearish sentiment, expectations that stock prices will fall over the next six months, rose 6.9 percentage points to 37.4%. The increase pushed bearish sentiment back up above its historical average of 30.5%. Since the beginning of the year, bullish sentiment has declined 16.0 percentage points, while neutral sentiment has risen 3.8 percentage points and bearish sentiment has risen 12.2 percentage points over the same time period. Both neutral and bearish sentiment remains above their historical average, while bullish sentiment remains below its historical average.

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 03/29/2017. Fourth-quarter NAAIM exposure index averaged 84.15%. Last week the NAAIM exposure index was 68.68 %, and the current week's exposure is 68.95%. It appears that money managers are on hold in anticipation of the start of earnings season next week. If traders like what they hear from quarterly earnings reports they should start rotating money back into equities to drive the NAAIM Exposure Index higher.

NAAIM Exposure Percent

Trading Strategy

Markets dipped slightly over the last week as investors began to question President Trump's ability to move forward with promised legislation. The doubt was sparked after House Republicans failed to vote on a replacement for the Affordable Care Act (aka Obamacare), Trump's first attempt to pass major legislation since being elected. Much of the market momentum since Election Day has been due to hopes that a new administration would enact policies favorable to the corporate environment and spur economic growth. Recently we commented "...that the proposed law isn't necessarily a repeal. It's basically a collection of revisions and tweaks designed to get the original Obamacare working properly, along with a giant tax cut...if this doesn't pass, the market doesn't get the tax cut. And the market cares a lot more about tax cuts..." The White House and Congress have signaled intent to pivot their attention toward tax reform. This will be another opportunity for the market to get the tax cut they so desperately desire. The chart below reflects uncertainty among traders - they are not willing to sell off equities, but not quite ready to commit to bidding prices higher. Also there is some sector rotation going which usually happens after a quarterly close and investors are waiting to see what earnings season looks like. In the current trading environment market neutral and short term directional trades have been profitable for us.

S&P Sector ETF March Performance

Feel free to contact me with questions,


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