May 14, 2018

While the major U.S. indices are still well off their all-time highs following the deepest correction in years, last week provided a huge confidence boost for bulls, as stocks rose all five sessions. The Gorilla was glad to see the Nasdaq and small caps lead the way higher, as it is another sign of healthy risk appetite among investors. Donald Trump was back in the spotlight, as this time his controversial exit of the nuclear deal with Iran made headlines. While the situation in the Middle East, especially in Syria, remains dire, equities ignored the escalation of the conflict between Israel and Iran, even as the price of oil continued to rise as a consequence. Apart from geopolitics, earnings were still in focus, and with the bulk of the quarterly reports already out, investors can conclude that the first quarter was even better than what the tax-cut boosted forecasts suggested.

It seems that despite the recent dovish Fed statement and the slightly deteriorating economic numbers these were not enough to stop the most important trend of the year; the rise in interest rates. The bond market continued to price in higher rates for the next few years while leaving long-term yields little changed, which led to a further flattening of the yield curve. While that is traditionally considered a recessionary warning, the actual economic data still doesn’t support a downturn, even as last week, the indicators pointed to a cooling economy. Both the CPI and PPI indices came in below expectations, and while those helped with inflationary worries, they also fueled speculation with regards to the looming end of the business cycle.

The technical picture got significantly better thanks to the broad-based rally in stocks, as the main benchmarks all tackled important hurdles successfully. The disagreement between the short- and long-term trends resolved in a bullish way, as the Gorilla expected, and the S&P 500, the Dow, and the Nasdaq all surged back above their 50-day moving averages while getting further away from the still rising 200-day averages. Small caps are still in a promising technical position, and the Russell 2000 is now just a hair below its all-time high, clearly outperforming the broader market. The Volatility Index (VIX) continued to drift towards the 10 level, closing near the 12 level on Friday, as market conditions are back to normal following the turmoil.

Market internals confirmed the rally, with all of the most reliable measures improving in the bullish environment. The Advance/Decline line is still the most promising indicator, as it hit a new bull market high, strongly outperforming the major indices, with advancing stocks outnumbering declining issues again, by a 5-to-1 ratio on the NYSE and by a 6-to-1 ratio on the Nasdaq. The average number of new 52-week highs jumped higher on both exchanges, rising to 120 on the NYSE, and 149 on the Nasdaq. The number of new lows fell sharply in the meantime, declining to 48 on the NYSE, and 45 on the Nasdaq. The percentage of stocks above their 200-day moving average also rose meaningfully, and it currently stands at 55%; finally showing an uptrend in the majority of stocks.

Short interest ticked lower thanks to the bullish price action, and the most-shorted issues outperformed the broader market again, as bears reduced their bets across the board. Ubiquiti Networks (UBNT) surged to a new all-time high after releasing its quarterly numbers, and with short interest at the sky-high level of 46%, bears could be in for further troubles. Seaworld (SEAS) also reacted well to the earnings report, hitting an almost one-year high, and with short interest still at 40%, it could fuel an old-fashioned short squeeze. Extra Space (EXR) is already in the midst of such a short squeeze, as it continued burning shorts throughout the week, scoring a new all-time high in the process. With its days-to-cover (DTC) ratio still at 12, further highs might be ahead for the stock.

Investors might be in for a quiet week after the recent busy period, with only a few key economic reports coming out, and with the earnings season drawing to a close as well. Tuesday and Wednesday will be the days to watch, with the retail sales report coming out on Tuesday before the opening bell, and building permits, housing starts, and industrial production highlighting Wednesday’s session. The Philly Fed Index will be released on Thursday, but all-in-all, the market will mostly be left alone, which could mean the rising trend that dominated last week might remain in place. The Gorilla thinks that given the positive fundamentals and improving technicals, everything is set for equities to finally leave behind the correction that followed the historic Trump Rally and head to new all-time highs. Stay tuned!