June 4, 2018

On Tuesday, it seemed that the period of low volatility ended, as global bond markets were shaken by the deepening Italian political crisis that resulted in a flight to safety across asset classes. While the structural problems in the country haven’t been solved, the immediate crisis was avoided by the weekend, and even as bonds continue to look shaky, stocks ended the week on a positive note. The recovery from the brief selloff was led by the Nasdaq yet again, while small caps continued to pull their weight as well. The Dow finished the week in the red, and the S&P 500 also managed to climb back to positive following the better-than-expected government jobs report on Friday.

Economic numbers finally got back on track last week after a less-than-stellar period, and the Gorilla hopes that this will mark a major turning point. The CB Consumer Confidence Index missed the consensus estimate, but despite the small negative surprise, the measure is still close to its all-time high. The prelim GDP print was also a tad below forecast, but personal spending came in much higher than expected. The ISM manufacturing PMI beat expectations and the government jobs report showed that the labor market is still robust. Non-farm payrolls increased by 223,000 compared to the expected gain of 190,000, the unemployment rate ticked lower to 3.8%, and wages were also higher than expected. The bullish numbers mean that a rate hike by the Fed is still very likely this month, despite the recent turmoil in global markets.

The technical picture reflects the recent divergence between the major indices, as the Nasdaq, and even the slightly weaker S&P 500, are in much better shape than the main laggard, the Dow. That said, all three benchmarks are above their 50- and 200-day moving averages, but the Dow is very close to its short-term indicator compared to its peers. While large caps are weak, small caps are confirming the end of the correction, as the Russell 2000 continued to march to new all-time highs, finishing the week well above its key moving averages. The Volatility Index (VIX) spiked to 18 following the long weekend, but as the mini-panic faded, it drifted back to the reassuring 13.50 level on Friday.

Market internals continue to support the bullish case, as the brief volatile period left the market ’s healthy structure intact, and the relative strength of small caps still shows in the most reliable measures. The Advance/Decline line resumed its relentless advance, and similar to the Russell 2000, it closed at a new bull market high, as advancing stocks outnumbered declining issues by a 3-to-1 ratio on the NYSE and by a 5-to-1 ratio on the Nasdaq. The average number of new 52-week highs bounced back on both exchanges, rising to 105 on the NYSE, and 169 on the Nasdaq. The number of new lows also edged higher, climbing to 57 on the NYSE, and 47 on the Nasdaq. The percentage of stocks above their 200-day moving average was virtually unchanged at 54%, and the Gorilla thinks that the recent stability of the measure is already an improvement.

The broad short squeeze continued in earnest on Wall Street after Tuesday’s scare, as the most shorted issues clearly outperformed the major indices yet again. Applied Optoelectronic (AAOI) went parabolic in the second half of the week after a consolidation period, and the stock might add to its 30% gain this week, as short interest stands at 77%! Extra Space (EXR) also delivered on its promise, as it hit a new all-time high last week, while the days-to-cover (DTC) ratio rose further, to 14 in the meantime. The short-squeeze in Microchip Technology (MCHP) continued unabated, as the stock jumped another 6%, and with its DTC ratio at 11, bears could be in for a real struggle.

Traders might be able to take a short breather after last week’s turmoil, as the economic calendar is almost empty this week, with only the ISM non-manufacturing PMI coming out on Tuesday. The measure has been showing some weakness lately, and bulls are hoping for a rebound after last month’s negative surprise. As the next Fed meeting is rapidly approaching and bond markets are signaling uncertainty regarding the Central Bank’s next move, every release has the potential to move the market. The Trump administration activated the steel and aluminum tariffs towards the previously exempted countries last week, and the Gorilla thinks that the possible escalation now poses the biggest threat for bulls, even as the market’s strength has been undeniable lately. Stay tuned!