June 25, 2018

Wall Street is still the island of calm from a global perspective, as volatility remains low, growth stocks and small caps are performing admirably, and all of the major indices are in encouraging technical positions. That said, there are clear divergences between the best performing and the lagging segments domestically, while Europe and Asia are looking troublingly weak. The ongoing tit-for-tat tariff war between the U.S. and China weighed heavily on markets throughout the week, with the number of sectors affected rising rapidly. The Nasdaq and the Russell 2000 shrugged off the global turmoil and hit new all-time highs before turning slightly lower toward the end of the week, while the Dow and S&P 500 continued to perform weaker.

Economic numbers were few and far between last week, with a focus on the housing market that has been under some pressure lately as Treasury yields hit multi-year highs. The three key indicators were a mixed bag, as building permits and existing home sales came in below expectations, while housing starts handily beat the consensus estimate. For now, housing is still clearly on a growth trajectory, but as interest rates are expected to rise further, the segment could be in for a slowdown. The energy segment was also in the spotlight, with a surprisingly big crude inventory draw and a modest OPEC supply rise lifting the price of oil and energy stocks after a highly volatile week.

The technical setup deteriorated slightly thanks to the strong divergence between the major indices, with the Dow falling below its 50-day moving average, signaling a weakening of the advancing trend. The S&P 500 and the Nasdaq are still above their short-term moving averages, and all three benchmarks are well north of their long-term indicator, as the underlying trend is intact. Small caps have been the undoubted leaders of the bull market ever since the beginning of the tariff war, and even after the late-week pullback, the Russell 2000 is just shy of its all-time high it hit on Wednesday. The Volatility Index (VIX) got close to the 15 level twice last week, but finished back near 13, as stock investors remained optimistic.

Market internals still support the bullish case, and as long as small caps remain strong it is unlikely that we will see major troubles “under-the-hood.” The Advance/Decline line drifted sideways while the major indices were mixed, as advancing stocks still outnumbered declining issues by a 2-to-1 ratio on the NYSE and by a 4-to-1 ratio on the Nasdaq. The average number of new 52-week highs continued to decline on both exchanges, falling to 88 on the NYSE, a 163 on the Nasdaq. The number of new lows increased in the meantime, rebounding to 62 on the NYSE, and 45 on the Nasdaq. The percentage of stocks above their 200-day moving average dropped alarmingly, despite the small-cap rally, and the current 53% reading is way below what the Gorilla would like to see.

Some analysts are calling the recent months’ move in the most shorted issues “the largest short squeeze in history,” as bears got smashed by the more than 25% rally in the segment. Duluth Holdings (DLTH) surged higher for the second week in a row, rising by almost 20%, and short interest is still sky high at 52%. Iron Mountain (IRM) could be ready to pop higher too, as the stock got close to hitting a six-month high, and with a days-to-cover (DTC) ratio of 14, shorts could provide an additional boost to the rally. Public Storage (PSA) delivered another great week for bulls, gaining 6%, and shorts seem to be in big trouble, given its DTC ratio of 13.

With the exception of Monday, there will be crucial economic releases coming out every day this week, with the CB Consumer Confidence highlighting Tuesday’s session, and the durable goods report, the final GDP print, and the Chicago PMI being released on Wednesday, Thursday, and Friday respectively. Although it’s unclear how the current divergences will be resolved, the Gorilla is confident that with the current fundamental backdrop, any correction should be treated as a buying opportunity, especially after the lengthy consolidation of the recent months. The strength in growth issues is also a bullish sign for the coming months, and while the market will likely slow down significantly during the summer, massive gains can build up in seemingly slow markets. With that in mind, stay tuned for an interesting week!