May 21, 2018

It was challenging to make sense of last week’s price action on Wall Street, but if one takes a step back, it’s clear that bulls still have all the reasons to be confident. The choppy and slightly frustrating days left the rising trend intact with regards to the major indices, even as the Dow, the S&P 500, and the Nasdaq all finished in the red, while the Russell 2000 surged to a record level. Geopolitics, and of course interest rates, remained all the rage throughout the week, as worries regarding the U.S.-Chinese relations resurfaced, and the crisis in the Middle East deepened. Despite the multi-year highs in oil, equity investors were not spooked by the Israel-centered woes, and even the fresh six-month high in the dollar wasn’t enough to break the advancing trend.

It was a relatively quiet week concerning economic releases, but not so much for the bond market, as Treasury yields experienced wild swings across the curve. The moves were likely driven mostly by emotions, as the yield on the 10-year surged past 3%, since the economic outlook didn’t change radically. The retail sales report provided the biggest negative surprise, as both the headline and the core number came in below expectations. Housing starts also missed the consensus estimate, and while building permits were in line with expectations, the housing market seems to be losing its momentum yet again. On the flip side, industrial production beat expectations in April, and the better-than-expected Philly Fed and Empire State indices point to solid growth in manufacturing too.

The technical picture remains encouraging for bulls, as the major indices seem to be on track to leave behind the 3-month long correction. The Dow, the S&P 500 and the Nasdaq are all above their 50- and 200-day moving averages, and thanks to the recent rally, the short-term indices are likely to turn higher again soon. Small caps are spearheading the recovery after a brief period of weakness, as the Russell 2000 took out its January high well ahead of the broader indices. The Volatility Index (VIX) closed at 13, near the weekly open, despite a spike to the 15 level on Tuesday, as the “boring” sessions that followed pushed the measure lower.

Market internals are still supporting the bullish case, thanks to the rally in small caps, even as some of the measures deteriorated last week. The Advance/Decline line, which has been a very reliable indicator in recent years followed the Russell 2000 to a new bull market high, as advancing stocks 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 was modestly lower on both exchanges, dipping to 113 on the NYSE, and 136 on the Nasdaq. The number of new lows ticked higher in the meantime, rising to 61 on the NYSE, and 50 on the Nasdaq. The percentage of stocks above their 200-day moving average edged lower and closed the week near 54% again, as this measure is still the one that concerns the Gorilla the most.

The most shorted issues outperformed the broader market again, as bears are losing hope that the recent correction was more than just a temporary blip in the bull market. Late-coming shorts of Fossil Group (FOSL) are already in a precarious situation, following this month’s rally to a new 12-month high in the stock, and given the short interest of 41%, there could be more pain ahead for bears. Microchip Technology (MCHP) took a breather after two weeks of hefty gains, but with its days-to-cover (DTC) ratio still at 11, another leg higher might be just ahead. Zions Bancorp (ZION) also sports a DTC ratio of 11, as the stock has been a standout performer among financials in recent months. Looking at its recent price action, there is no reason for bears to be optimistic.

It will be another relatively quiet week as far as economic reports are concerned, although there is a possibility of a significant move following the FOMC meeting minutes on Wednesday or after the durable goods report on Friday. The market signals an almost 100% chance of a rate hike in June, and should the minutes turn out to be strongly dovish, a major “re-pricing” event could occur. While currencies and bonds would be the most affected, equities are also highly sensitive to rates. As the dollar’s recent rise caused a mini panic in emerging market assets, without real contagion into developed assets (yet…), a pullback in the currency would be much welcomed by investors. That said, the Gorilla thinks that the rising trend that started three weeks ago is intact, and that the benefit of the doubt is now on the side of bulls. Stay tuned!