July 2, 2018

The past few weeks were all about the divergences between the major indices, but last week, the tide turned, and the previously leading Nasdaq spiked lower together with the small-cap segment. The Chinese yuan’s plunge, which was the trigger of several corrections in recent years, sparked a flight to safety trend, and the weakness in Asian and European stocks continued to weigh on global sentiment too. Some analysts suspect that the Chinese currency didn’t lose ground on its own and that the trade war with the U.S. entered a new phase with the alleged intervention. Whatever the case, nervous trading dominated Wall Street for most of the week, although Friday’s bounce helped bulls’ mood before the weekend.

The most awaited economic releases were worse-than-expected last week, although they were far from disastrous, and the generally positive outlook remains intact. While the CB Consumer Confidence Index ticked lower unexpectedly, the previous reading was revised higher, and the indicator is still just slightly off its all-time high. The durable goods report was mixed, as the headline number beat the consensus estimate, but the more reliable core measure provided a sizable negative surprise. The final GDP print was also lower-than-expected, as well as personal spending, but the better than forecast Chicago PMI made the Gorilla smile on Friday, as manufacturing continues to propel GDP growth.

While the correction left the advancing trend intact with regards to the major indices, the technical picture continued to deteriorate for the second week in a row. The Dow has now violated both its 50 and 200-day moving averages, and although it managed to close slightly above its long-term indicator, the industrial benchmark is clearly the weakest link. The S&P 500 and the Nasdaq are still above both moving averages, even as the former dipped briefly below its short-term measure. Small caps are following the tech benchmark closely, as the Russell 2000 remains above its key indicators, despite its steep pullback. The Volatility Index (VIX) almost breached the line-in-the-sand 20 level during the Monday scare, and although it remained below that, it’s still at its highest level since late-May.

Market internals confirmed the short-term correction, as all of the most reliable measures ticked lower last week. The Advance/Decline line held up encouragingly well despite the small-cap weakness, and advancing stocks still 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 took a nosedive on both exchanges, plunging to 47 on the NYSE, and 61 on the Nasdaq. The number of new lows jumped higher in the meantime, climbing to 101 on the NYSE, and 87 on the Nasdaq. The percentage of stocks above their 200-day moving average continued to decline, as the ratio fell well below the 50% level, closing the week at 48%, as participation remains weak.

While the “largest short squeeze in history” might have ended last week thanks to the broad correction on Wall Street, there were still several stocks posting gains among the most shorted issues. Duluth Holdings (DLTH) continued its ramp with another +20% week, and since short interest is still at 52%, there could still be plenty of burned bears left. Current GorillaPick, Hormel Foods (HRL), has been flying under the radar lately, but since it sports a days-to-cover (DTC) ratio of 13, last week’s relative strength might be the precursor of a healthy rally. Kellogg (K) has also been outperforming the broader market in recent weeks, and given its DTC ratio of 10, the stock could be ready to continue to move higher in July.

As the country celebrates Independence Day on Wednesday, trading volume could be well below average throughout the week, although Friday’s session will likely bring some fireworks of the financial kind. The government jobs report will come out on the last session of the week, and with the FOMC meeting minutes being released the afternoon before, volatility could surge higher. Although the bond market clearly points to two more rate hikes this year, which is in line with the Central Bank’s recent guidance, the Fed is always able to surprise investors. The ISM manufacturing and non-manufacturing PMIs are also coming out on Monday and Thursday respectively, and given the recent pullback in stocks, significant moves are possible in the low-volume environment. Stay tuned!