Stocks Overbought - Increase Slightly
Stocks overbought - the S&P 500 was up 3 basis points after giving back some of its early gains on Tuesday.
The other indexes were also slightly positive. As you can see from the chart below, the S&P 500’s 14 day relative strength index is at 69.49 which puts it just 51 basis points away from being overbought.
One more up day should do it. The CNN Fear and Greed index fell from 77 to 74 which took it from extreme greed to just greed. Even though stocks were up, the index fell partially because of the 2.8% increase in the VIX to 12.50.
In January stocks levitated while the VIX increased. Historically, this hasn’t meant much, but in that case it added to my call for a pullback because sentiment was the highest on record and global synchronized economic growth was ending.
This current market isn’t like January in terms of the VIX because we won’t see such a washout in the short VIX trade anytime soon as some of those products were discontinued. The next correction will be different.
Stocks Overbought - President Trump Jabs Twitter, Facebook And Google
The best sector was real estate which was up 1.19% and the worst sector was telecom which was down 0.48%.
President Trump commented on Facebook, Twitter, and Google, saying they “have to be careful” of political bias. He said they are in “troubled territory.”
The President controls the executive branch which is in charge of regulations, which means his comments on these firms are important. Twitter stock fell 1.11%; Facebook stock fell 0.68%, and Alphabet stock fell 0.86%.
Any action against these firms would be a big problem for the market as Facebook and Alphabet are two important members of the FAANG market leaders.
Facebook stock has been on a rough run after its disappointing earnings report. The stock is down 2.84% which is a double digit underperformance compared to the S&P 500.
I’m still not willing to write off the stock though because Instagram is probably the most important property on the internet for millennials.
The tech sector is up 15.99% year to date which means Facebook is doing 18.83% worse than it. As you can see from the chart below, full year 2019 Facebook earnings estimates have had an unusually sustained dip.
The stock and earnings estimates probably won’t rebound until Facebook more clearly explains the new costs associated with monitoring the website during its next earnings conference call.
Stocks Overbought - The Dollar & Treasuries
The dollar index is in a tailspin as it is pushing stocks and commodities higher. If it really crashes, I will worry about commodity prices driving inflation higher. For now we get to watch international stocks outperform domestic stocks for the first time in a while.
The dollar index peaked at $96.73 and is now at $94.82.
The 10 year treasury yield increased 3 basis points on Tuesday and fell one basis point in early trading action on Wednesday, leaving it at 2.87%.
The economy needs the 10 year yield to rise to avoid a yield curve inversion. I correctly called the recent decline in the yield. I still don’t see it getting above 3%. The 2 year yield spiked 2 basis points on Tuesday and fell one basis point in early trading on Wednesday, leaving it at 2.66%.
The difference between the two curves is 21 basis points. If I was rooting for a delay in the inversion, I would rather see the 10 year yield rise than the 2 year yield fall. I feel rate hikes make a rise in the 2 year yield inevitable.
It is just 2 basis points off its cycle peak it hit on July 27th. The chance of at least 2 more hikes in 2018 is now at 64.7% which is down from 72% in the previous day. These percentages will be very important after the Fed’s rate hike decision on September 26th.
Stocks Overbought - Earnings Revisions Stagnate
The most important thing I look at to measure stocks is earnings. Then the second is economic reports and the third is technical analysis.
Finally, the geopolitical news and domestic political new vacillate in importance tremendously. The current political scenario is much more important than it was a few years ago because there is the threat of a trade war.
Whether or not it will occur is irrelevant to the fact that it has become a new risk factor.
I’m mentioning the order of importance because the earnings revisions and technicals agree that stocks should be sold.
The recent economic reports such as the core durable goods orders and consumer confidence suggest stocks should move up.
Furthermore, the wildcard that is the trade war threat also suggests stocks should move up because America has made a preliminary trade deal with Mexico.
Stocks Overbought - As you can see from the chart below, the earnings revisions have switched to negative just like in January.
The market was cheap in February and March because the revisions were great, and stocks were falling. As I mentioned, earlier there won’t be a short VIX implosion again, but that doesn’t mean stocks won’t fall.
We have technical indicators showing warning signs and Q4 estimates stagnating. This is enough for me to sell stocks even though the potential for an economic slowdown has diminished this week.
Once the technical warnings signs are triggered, I look for fundamental support for a correction. The support appears clearly in the chart below.
Stocks Overbought - Conclusion
The odds for a 10% correction increase the more stocks become overbought. The sentiment is frothy, but nothing can compare to January because it was the most euphoric market in history.
Don’t let recency bias make you think there needs to be record euphoria for there to be another correction. Declines of 10% are normal and should be expected when the technicals and fundamentals reverse course.
Don’t fear a recession every time stocks fall because corrections are great buying opportunities. The next recession is still at least a year away according to the yield curve and the leading indicators.