July 9, 2018

The major indices finished last week in a very bullish fashion, as Wall Street saw a broad rally, despite the very low trading volume around Independence Day. Although the divergences that have been apparent for several weeks are still present, the correction that was triggered by emerging market worries and trade war fears is likely over. The Nasdaq and the Russell 2000 led the rally from the short-term lows yet again, and the tech index and the small cap benchmark finished the week a little more than 1% below their record highs on Jobs Friday. The advance was boosted by the end of a political crisis in Germany, while the “Goldilocks” jobs report led to a classic short squeeze before the weekend.

Although the government jobs report was not spectacular, as the unemployment rate ticked higher to 4% while wage growth disappointed, the better-than-expected non-farm payrolls and the upward revision of the previous release lifted stocks. Rate hike odds edged lower after the much-awaited report, as Treasury yields retreated, but short-term rates still finished the week higher thanks to the positive news that came out earlier. The ISM manufacturing and non-manufacturing PMIs both beat the consensus estimates, as both segments continue to show solid growth expectations. The minutes of the Fed’s recent meeting were also released last week, but the Central Bank didn’t cause big surprises, as Jerome Powell & Co reiterated the rate hike schedule for the rest of the year.

The technical setup remains bullish even though the rally from the spring correction lows could be best described as two-faced, with strong divergences between the major indices and between global and domestic markets. While the Nasdaq and the Russell 2000 are still clearly in bullish short- and long-term trends, with their rising 50- and 200-day moving averages in a perfectly bullish alignment, the Dow and the S&P 500 are much more neutral. Both moving averages are virtually flat with regard to the Dow, while even the slightly stronger S&P 500 is just one selloff away from the dreaded “Death Cross.” The Volatility Index (VIX) is still notably higher than it was during the “Trump Rally” last year, but Friday’s 14 level is well below the danger zone above 20.

Market internals remain mixed, although a bullish bias is still apparent among the most reliable measures. The Advance/Decline line continues to show a positive divergence compared to the major indices, as it blasted higher to a new bull market high this week, as advancing stocks outnumbered declining issues again by a 4-to-1 ratio on the NYSE and by a 6-to-1 ratio on the Nasdaq. The average number of new 52-week highs increased on both exchanges, rising to 84 on the NYSE, and 90 on the Nasdaq. The number of new lows edged lower in the meantime, falling to 48 on the NYSE, and 42 on the Nasdaq. The percentage of stocks above their 200-day moving average is still stuck just above 50%, which continues to raise questions about the level of participation in the bull market.

The most shorted issues were among the best performing segments once again last week, as the previous week’s steep correction was almost completely erased thanks to the global risk-on shift. iRobot (IRBT) finally broke out from a narrow range, and with short interest at 41%, bears might be in for a rough ride. Mattel (MAT) entered a correction in June after a 50% rally, but this month the stock finished in the green every day, and since it sports a days-to-cover (DTC) ratio of 14, another leg higher could be ahead. Iron Mountain (IRM) surged to a 6-month high toward the end of the week, and given its DTC ratio of 15, the rally might have only just begun.

This week will be all about inflation as far as economic releases are concerned, as besides the U of M Consumer Sentiment Index on Friday, the PPI and CPI indices will come out on Wednesday and Thursday respectively. As the Fed’s rate hike schedule seems stable, the Gorilla thinks that only a major surprise in the inflation measures could change the status quo on Wall Street. While emerging market troubles are likely here to stay, despite last week’s global feel-good rally, the resilience of domestic stocks is very impressive. The Gorilla thinks that the bullish momentum of the leading segments could propel the next leg higher in the bull market. That said, should global markets remain under pressure, weakness could “infect” domestic markets as well, so risk shouldn’t be neglected here. Stay tuned!