A Pause That Refreshes?

“Get out your party hats ladies and gentlemen, the markets hit all-time highs.

After increasing equity exposure in portfolios on the 11th, as the markets pulled back to the previous break-out support levels, I suggested a push to new highs was likely.”

The one thing that we addressed several times last week on our daily podcasts was the short-term overbought condition needed to be resolved before the markets could make a year-end push to 3000.

There has been a pretty well defined upward trendline (black dashed line) since the April lows which has consistently provided better entry opportunities to increase equity exposure.

While we are currently fully weighted in existing portfolios, we must take advantage of these entry points to “on-board” new clients. This is always the biggest challenge for any adviser.

As stated, our existing portfolios are currently fully weighted toward equity risk as there seems to be little which can derail this market currently. We have moved stop-loss levels up to recent lows, added some defensive positioning, and have added bonds as rates have climbed above 3%.

Speaking of rates, each time rates have climbed towards 3%, the market has stumbled.

There is also a reasonable match with oil prices.

This is particularly interesting with respect to the ongoing bullish narrative. Tariffs, higher interest rates, and higher oil prices are ultimately a direct tax on the consumer. Such will ultimately weigh on consumption, earnings, and the economy.

Another concern for the rally is the participation continues to narrow. Small caps, after leading the rally higher from the March lows have lost their “mojo.”

Same for Mid-cap stocks.

This suggests that much of the “speculative” nature of the market seen early this year has subsided and risk is being concentrated into fewer areas.

As Steven Vanelli via Knowledge Leaders Capital blog noted on Friday

“Small caps have underperformed mid/large caps by about 5% since making a relative high June 21, 2018. There is support nearby, but if small caps underperform US mid/large caps by another 5%, then the technical picture could change for the worse.”

But there is more to this story than just relative underperformance. As Jesse Felder noted in his blog last week, breadth is becoming decidedly more bearish.

So, the real question is whether the recent struggles with the market are simply just a pause that refreshes or the early stages of a more important topping process?

Over the past 50-years, when the market has posted a new high, failed, and then posted a subsequent high at the same time the Federal Reserve, and long-term rates, were rising – it was a significantly more important topping process.

1972 – Prior to the 1973-1974 bear market.

1999 – Prior to the Dot.com crash

2007 – Prior to the Financial Crisis

Today

It is too early to know just yet whether we are just experiencing a pause that refreshes or if we are at the beginning of a more important juncture between rates and the markets. We will only know for sure in hindsight.

For now, there is really no one is really concerned with the risks. As Dr. Ed Yardeni noted last week:

“The latest relief rally reflects mounting confidence that Trump’s trade war won’t escalate into one that depresses the economy and corporate earnings, which continue to soar. In addition, there is less fear lately that the Fed’s policy normalization will trip up the bull market. Earlier this year, there was fear that a 10-year US Treasury bond yield above 3.00% would be bearish for stocks. It recently rose back slightly above that level, yet it was widely deemed to be bullish for financial stocks. Go figure!”

He is right, which is why we have remained allocated to equities and have been opportunistic in adding exposure.

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