Bears Gain On The Bulls

Last week, I discussed the issue of “lots of volatility with little movement” stating:

“The last couple of weeks have experienced a sharp rise in price volatility. While stocks have vacillated in a very tight 1.5% trading range since the beginning of June, there has been little forward progress to speak of. However, notice that support at 2415 (50-dma) has remained solid as ‘robots’ continue to execute their program of ‘buying the dips.’”

“This lack of progress keeps us ‘stuck’ with respect to portfolio positioning.”

I remain very cautious on the overall market, currently, and the deterioration is leadership remains concerning. However, the trend remains bullishly biased which keeps portfolios allocated on the long side for now.

With that said, the recent “sideways” movement has NOT worked off the previous overbought condition of the market on an intermediate term basis as shown below.

As I have stated previously, the presence of the primary “sell signal” (signal 1) has suggested price weakness in the market would likely continue. However, the recent corrective action has now pushed the “secondary” signal towards initiation. Previously, the confluence of both intermediate-term “sell” signals have historically been in conjunction with deeper corrections in the market.

I am giving the market a bit of “room”, given the week was interrupted by a holiday which tends to let the“inmates run the asylum”. Next week will give us a better picture of the current risk/reward setup.

Despite the uptick in volatility last week, volatility remains suppressed at historically low levels. As shown in the chart below, the recent “back and forth” action has reduced the overbought condition of the market short-term with stocks testing the bullish uptrend. Furthermore, while the market is oversold on a“daily” basis, versus “weekly” as noted above, the high-level of complacency DOES NOT align with the tradeable set ups noted previously by the vertical red dashed lines.

Let me reiterate from last week:

“I continue to suggest a healthy regimen of risk management practices in portfolios by following some rather simple guidelines (the same ones that we followed to harvest profits recently as noted above.)

Tighten up stop-loss levels to current support levels for each position.
Hedge portfolios against major market declines.
Take profits in positions that have been big winners
Sell laggards and losers
Raise cash and rebalance portfolios to target weightings.”

For now, as noted above, let’s wait until next week to see if the “bears” can continue to gain on the “bulls”. If they do, we will then begin to evaluate models to reduce overweight positions, raise some additional “cash” and potentially begin to deploy some hedges.

Approaching A Bond Buying Opportunity

Last week, I discussed “why” interest rates can NOT go substantially higher from current levels. To wit:

“As I have discussed many times in the past, interest rates are a function of three primary factors: economic growth, wage growth, and inflation. The relationship can be clearly seen in the chart below by combining inflation, wages, and economic growth into a single composite for comparison purposes to the level of the 10-year Treasury rate.”

“As you can see, the level of interest rates is directly tied to the strength of economic growth and inflation.”

This week, I want to look at interest rates from a purely technical point. Interest rates, like stock prices, are bound by the laws of physics. Prices can move only so far in one direction, before eventually returning to the mean. When rates plunged from 2.6% to 2.15% recently, bond prices had become extremely overbought and some correction action was expected.

I have been recommending to readers over the last couple of months to withhold adding bond positions given the level of richness in bond prices. That advice has played well, and the recent spike in interest rates has pushed bond prices to important levels of support while reducing much of the previous overbought condition.

As noted last week:

“However, bonds are not yet oversold. Therefore, we will hold off on adding to existing bond exposures, or adding new positions, this week with the expectation rates could rise a bit further.”

The rise in rates last week has pushed the 10-year yield to some of the highest “overbought” conditions witnessed in the past 25-years. Each time rates have been at these levels previous TWO things have happened.