Time to Become Bearish?
The stock market was extremely overbought entering this week, but rallied in 4 times as it increased 0.85%. However, the rally has only gotten more extreme. Which means we'll start seeing more bearish than many have recently been. Personally, I’m extremely bearish on the short term which I consider to be the next month. Yet, I’m slightly less bullish on the intermediate term than I have been.
Mostly because the gains that were expected to occur in 2020 have occurred in the past month. This is the opposite of last year in which Q4 2018 set up Q1 2019 very well. Now Q4 2019 is setting up Q1 2020 poorly. However, most investors expect stocks to correct before we get to Q1.
S&P 500 is up 23.39% year to date. A rally in Q1 was fine, but the recent rally since October has gone overboard. CNN fear and greed index stayed at 91 which is extreme greed. It can’t increase much further which means just staying this high is very bearish.
S&P 500’s 14 day relative strength index is at 69.63. It is 0.37 away from giving off a bearish signal. It was within a few points of this level before the prior 2 corrections this year. This has been a global rally as the MSCI ACWI and the S&P 500 have been up for 5 straight weeks for the first time since December 2017.
If stocks rally much further, this level of euphoria will rival the January 2018 level. If you’re a bull, you should cheer for a small correction because such a level of euphoria precedes sharp spikes in volatility. VIX fell 0.66 to 12.07 on Friday. It may be good idea to buy large amount of protection. Now, I’m expecting a big spike in the VIX to the low 20s in the next few weeks.
Internals of the S&P 600, which is a small cap index, show the index is more overbought than the S&P 500. 70% of small cap stocks are above their 50 day moving average and 66% of large caps are above that level. In the MSCI Europe index, 80% of stocks are trading above their 50 day moving average. A global correction is coming soon.
Details Of Friday’s Action
One of the leaders of this euphoric action is the semiconductor index as investors are extremely excited about the possibility of a global cyclical upturn similar to 2017. There isn’t clear evidence that there will be an upturn. But investors are jumping the gun. The chart below shows how they are more optimistic than they probably should be based on the fundamentals.
As you can see, the year over year change in the SOXX semiconductor ETF is almost 40% while the ISM manufacturing PMI is down almost 20%. Usually the 2 are highly correlated. Semiconductors aren’t related to manufacturing, but they both are impacted by global growth. SOXX ETF is up 49.29% year to date and 14.63% since October 8th. It’s clear that a 14.63% gain in one month is unsustainable.
At this point a recovery in 2020 is already priced in. If it happens, don’t expect this index to rally more and if it doesn’t happen, expect this index to crater. This is a lose/don’t win scenario. You have little upside and a lot of downside.
Nasdaq was up 0.48% and the Russell 2000 was up 0.31% on Friday. Small cap index is near where it has peaked 4 times this year. It’s currently down just 1.3% from its high for the year. It won’t hit a record high unless the Fed guides for a rate hike or the market starts pricing one in. While I don’t see a cut in 2020, we are very far from the market expecting a hike.
There is now just a 45.2% chance of a cut next year. If volatility returns, expect the odds for a cut to increase a bit. It isn't advised to put any risk on right now with the level of euphoria in the market. The market is too overbought to even invest in sectors I like.
Speaking of sector performance, the 3 down sectors were utilities, real estate, and energy which were down 0.38%, 0.24%, and 0.81%. Unbelieveably, utilities are very oversold and will probably bounce soon. Since October 24th, the sector is down 4.74%.
Biggest winners on Friday were healthcare and technology which increased 0.8% and 0.59%. Also there is the rally in semiconductors which are a part of tech. Healthcare probably rallied because Michael Bloomberg entered the presidential race on Thursday evening. He is a moderate who likely wouldn’t support Medicare for All.
Other good news for the sector comes from the polls from NY Times/Siena. Biden was up big in North Carolina, Michigan, Florida, Arizona, and Pennsylvania. Warren was up in Wisconsin by 2 points.
Huge Yield Curve Steepening
In keeping with the recent trend, the 10 year yield rose 2 basis points to 1.94%. This is part of the risk on trade that’s betting on a cyclical upturn. 2 year yield was up 1 basis point to 1.67% which means there is a 27 basis point difference between the two.
There has been a huge amount of curve steepening recently as you can see from the chart below. It shows the 50 day rate of change in the 10 year 3 month curve. That’s over 70 basis points of steepening which has only been beaten in this number of days 3 other times this cycle.
We saw a lot of steepening in the 2nd half of 2013. 2014 was a great year for the economy. It’s clear markets are very excited about next year’s economy. It’s really tough to see if the markets are right.
We don’t have much evidence to go by other then that the data hasn’t gotten much worse recently. It could be bottoming, but not many indicators have pushed higher yet.