April 23, 2018

The major U.S. indices had a two-faced week— until Wednesday— everything looked set for the recovery to continue, as price action was bullish, while technicals and the geopolitical backdrop were improving. The last two sessions of the week saw a sharp reversal on Wall Street, and the key benchmarks finished back where they started, with the Nasdaq leading the way lower. Apple (AAPL) has been the biggest drag on the technology segment, as the most valuable public company got hit hard, as supplier reports suggested that the iPhone maker might be facing demand issues. While the late-week weakness of the Nasdaq is not a bullish sign, small caps remained resilient during the selloff, which could provide stability for the broader market this week.

Economic numbers were in line with the modest growth narrative, and even the housing market, which has been feeling the pain of rising interest rates lately, provided a positive catalyst. Housing starts and building permits both beat consensus estimates, while the previous month’s figures were also revised upward. The most-awaited retail sales report was also slightly better-than-expected, while industrial production slowed less than what was forecast for March. The decent numbers contributed to the reversal in equities, as short-term Treasury yields hit new decade-long highs, which spooked investors yet again, as the Fed’s tightening cycle is still considered one of the biggest threats to the bull market.

The technical picture still looks stable, despite the late-week dip, with the major indices holding up above their rising 200-day moving averages, even as their 50-day averages are still trending lower. The Dow, the S&P 500, and the Nasdaq briefly rose above their short-term averages last week, but now they are all back between the two indicators. On a positive note, small caps have been showing relative strength this month, with the Russell 2000 recapturing its 50-day moving average before the other broader indices, and remaining above the measure throughout the week. The Volatility Index (VIX), which has been in the epicenter of the February crash, retreated below the widely watched 20 level and closed near 17 on Friday.

Market internals continued to improve, thanks to the relative strength of small caps, and even though some of the measures are still weaker than what bulls would want to see, they don’t confirm a significant market top. The Advance/Decline line continues to show a positive divergence, as it surged to a new bull market high last week, as advancing stocks outnumbered declining issues by a 2-to-1 ratio on the NYSE and by a 3-to-2 ratio on the Nasdaq. The average number of new 52-week highs increased slightly on both exchanges, rising to 456 on the NYSE, and 60 on the Nasdaq. The number of new lows dropped in the meantime, falling to 43 on the NYSE, and 45 on the Nasdaq. The percentage of stocks above their 200-day moving average is just above the 50% level, as a lot of stocks are still struggling to resume their advance.

Short interest was little changed in the mixed environment, although some of the most shorted issues experienced wild swings thanks to the quarterly earnings releases. While Carvana (CVNA) already reported earnings in March, the stock surged by more than 20% last week, and with short interest still standing at 60%, new all-time highs could be ahead. TransDigm (TDG) broke out to new highs as well after a month of consolidation, as the stock is sporting a days-to-cover (DTC) ratio of 11, suggesting a narrow exit for bears. Hormel Foods (HRL) is also among the issues with the highest DTC ratios, with a reading of 13, and with the stock drifting sideways ever since its strong rally three weeks ago, another leg higher could be around the corner.

Traders are in for a busy week of economic releases, with key indicators coming out almost every day. The existing home sales report is first in line, the CB Consumer Confidence Index is scheduled for Tuesday, durable goods orders are coming out on Thursday, while the preliminary GDP print could stir up the market on Friday. The European Central Bank’s rate decision also has the potential to cause volatility on Thursday, as monetary policies are still very much at the center of attention. With the February crash still clearly affecting stocks, the Gorilla thinks that the consolidation period could continue this week, but given the positive shift in market internals, and the, so far, positive earnings picture, a powerful rally wouldn’t be a surprise either. Stay tuned!