S&P 500 Weekly Update: Despite What May Be A Short-Term Pullback Ahead, The Third Leg Of The Secular Bull Market Is Now Underway (NYSEARCA:SPY) (2024)

"Experience tells you what to do; confidence allows you to do it." - Stan Smith

The news headlines around us may be crazy, but the stock market continued to serve as a rock of stability, steadily rising while plenty of negatives were swirling around the financial world. I have been around the investment world for quite some time, including over three years here on SA, and it is the same skeptical stock market story that is being replayed during this bull market. The initial upside market breach in 2013 wasn't embraced, and the breakout at S&P 2,131 in 2016 was virtually scoffed at. The market action so far in 2017 is being viewed with plenty of disbelief.

I offer a different view. Three weeks ago the stair step market pattern that has emerged was brought to attention of the readers. One of the most constructive market scenarios that exists. With each day that the sideways pattern went on, an increasing number of pundits were busy writing off the so-called Trump rally. Every excuse not to get involved in the market was thrown at investors. Just when the cries got the loudest that the market was ready to roll over, the S&P 500 broke out of its recent range to new all-time highs and formed a new riser in that stair step pattern.

The initial leg of this major uptrend started in 2009. Paused in 2011 before embarking on a second leg that eclipsed the old highs, kicking off a secular bull market, before pausing again in 2015. The recent price action and vault to new highs now raises the odds that the third leg for this bull market has begun. Something that was thought to be impossible by many. After all, this bull market is too old and tired. It was supposed to roll over in 2015, the cycle was ending. It couldn't advance further. (sarcasm intended).

Wherever this rally stops, nobody knows, but my guess is that it will be when the same pundits turn around and tell us the rally has legs.

The fact that the S&P broke out recently amidst every imaginable political negative that is being tossed around is impressive. However, it isn't surprising the stock market marched to the drum beat of earnings and improving global economic data. The market is forward looking, and on both of those fronts, things are looking up.

Not only has the market been strong since the election, it has also been remarkably stable, leaving investors who are on the sidelines with little opportunity to get in. At 169 trading days through this Friday, the current streak without a 5% correction is the longest of the current bull market. The prior streak was 158 back in September 2014. That decline was all about a global slowdown, Ebola, Eurozone crisis, etc. The commentary back then declared it the second coming of 2007-2009.

None of that exists today, in fact, the scene is quite the opposite. Can something pop up and give us the pullback the masses are waiting for? That possibility always exists in the marketplace. The key ingredient of the strategy that I am working with is that any decline will be contained, and that should give investors confidence. Instead, the worries and excuses abound, overwhelming many market participants to the point of being frozen in place.

Amidst the chorus of negativity about the uncertainty the new administration brings to the table, Lloyd Blankfein takes the opposite view in a message delivered to members of his firm on February 9th.

"The change in the market today is from a cycle where we were of very low economic activity, consequently very low interest rates, and a very, very high level of - maybe call it pessimism about where we go. And it feels like we're changing to one in which it's going to get growthier. More growth out there, more opportunity and one in which we are getting a bit more optimistic." - Goldman Sachs CEO Lloyd Blankfein

The January Barometer is being rolled out again. Historically, as the first five trading days of January go, so goes the month; and as the month goes, so goes the year. Jeffrey and Yale Hirsch of the Stock Trader's Almanac report that 75% of the time (50 out of 67 instances) since 1950, the direction of the entire year (up or down) was the same as that of January. But when the S&P started the new year with a positive January, as it has done 40 times since 1950, it finished the year higher 36 times, success rate of 90%. We should also be reminded that last January was one of those years that the barometer did not hold true.

While 90% represents solid odds, the following piece of history is worth noting. There have been 31 instances in which the S&P in January performed equal to or better than this year's return, and the subsequent full-year return was negative only three times, with an average full-year return of 18.8%.

Economy

Scott Brown chief economist at Raymond James highlights three points that summarize the state of the economy now.

• Economic data have been subject to seasonal distortions, but recent figures have remained consistent with positive momentum in consumer spending and business investment.

• Optimism about the economy has increased since the November election, but a tight labor market and difficulties in getting President Trump's agenda through Congress are likely to be constraints. Global trade disruptions are the greatest risk.

• Monetary policy remains data-dependent, but the Federal Reserve is expected to raise short-term interest rates gradually

The third point is key as many investors are still wrestling with the fact that Fed policy is changing.

Manufacturing activity in the New York region continued to improve this month as the Empire Manufacturing report surged from 6.5 up to 18.7, which was the largest monthly increase since last June and the highest overall reading since September 2014.

Philly Fed index surged to 43.3 from the December reading of 23.6. The last time the index was this high was 1984.

This past week's release of the NFIB's monthly report on small business optimism came in higher than expected, rising to 105.9 from last month's reading of 105.8 and above the consensus expectation of 105. This reading is a 12-year high and the hiring plans index rose to a new 10-year high.

Headline PPI is accelerating higher, with Energy PPI by far the largest driver. Ex Food and Energy, Goods PPI is up only about 1.19% year over year and is not accelerating. Food prices continue their broad decline.

Retail sales surprised to the upside, increasing by 0.4%, as expectations were calling for a rise of 0.1%. Ex Gas and autos up 0.7%, versus expectations 0.3%

After an initial post election surge, which took homebuilder sentiment to its highest levels in over a decade, there has been a dip in sentiment over the last two months. In last week's report from the NAHB for the month of February, sentiment dropped from last month's level of 67 down to 65. The long-term trend, however, remains in an upward trend.

Housing starts were reported down 2.6% for January. The actual starts (1.24 million) were higher than expectations (1.23 million).

Global Economy

U.K. Construction Output year over year for December declined to 0.56% from the prior month's revised 1.8%. While U.K. Industrial Production year over year surprised to the upside.

French unemployment missed badly for Q4, with 10% of the labor force unemployed. Speaking of France, the first round of the 2017 French presidential election will be held on 23 April 2017. Should no candidate win a majority, a runoff election between the top two candidates will be held on 7 May 2017. In some ways, this could be another Brexit type moment that the market will have to comes to grips with.

Chinese Imports and Exports in January surged, with imports rising at their fastest pace in 4 years, on stronger domestic and international demand. Imports from the U.S. specifically rose 23.4%, the fastest pace in a year.

The Wall Street Journal reports:

"China's wait and see approach to U.S. President Donald Trump's periodic diplomatic outbursts has paid off with the president dropping his threat to upend a cornerstone of Beijing-Washington relations. After weeks of several phone run ins with world leaders, Mr. Trump committed to a longstanding agreement that the U.S. won't recognize Taiwan diplomatically in a phone call with President Xi Jinping late Thursday."

Jumping to conclusions on pundit speculation and media backlash usually backfires.

Earnings Observations and Valuation

A list of headlines for this earnings season are compiled daily and can be found here. A quick way to get a feel for how the earnings season is progressing.

The equity market has rallied for a variety of reasons, but one of the more important ones is the talk of cutting corporate taxes.

While the chart above may be a little difficult to see, what isn't difficult to understand is the red line on the bottom of the chart depicting the United States tax rate at 39.1%.

There are plenty of studies around on the effect of cutting the corporate tax rate. Like everything Wall Street, these estimates are all over the map. One that I just saw suggests that every one point drop in the corporate tax rate hypothetically adds $1.31 to the S&P earnings estimate.

Bank Of America Merrill Lynch suggests a more conservative view. Forecasting a $5-$6 bump to S&P earnings if the rate is dropped to 20%.

Cutting corporate tax rates will have varying effects on different sectors on the market. Here is a view of what sectors would benefit the most.

Pie in the sky, a wildly bullish view and dreaming? Perhaps there is a decent probability of this occurring and that is what the market is looking ahead to. In the meantime, many sit and scratch their heads in total disbelief of what is taking place in the equity market.

FactSet Research reports:

"As of Friday (with 82% of the companies in the S&P 500 reporting actual results for Q4 2016), 66% of S&P 500 companies have beat the mean EPS estimate and 53% of S&P 500 companies have beat the mean sales estimate."

"For Q4 2016, the blended earnings growth rate for the S&P 500 is 4.6%."

"The forward 12-month P/E ratio for the S&P 500 is 17.6. This P/E ratio is based on Thursday's closing price (2347.22) and forward 12-month EPS estimate ($133.49)."

Many are highlighting that the growth rate for the quarter isn't as robust as it should be. Let's take a closer look. One stock is accounting for nearly all of the recent decline in the S&P 500 earnings growth rate for Q4.

FactSet reminds us that during the past two weeks, the blended earnings growth rate for the S&P 500 for Q4 declined by 0.5 percentage points (to 4.6% from 5.1%). At the sector level, the Financials sector has seen the largest drop in earnings growth of all eleven sectors during this time. The earnings growth rate for the Financials sector has been cut nearly in half over the past two weeks (to 11.0% from 20.0%). Within the Financials sector, American International Group (AIG) has witnessed the largest decline in EPS (to -$2.72 from $1.17) for Q4 2016 over this time frame.

I ran across this interesting article on current market valuation from Michael Batnick, Ritholtz Wealth Management. The piece also includes his thoughts on the often debated cape ratio.

The Fed and the U.S. Dollar

Just about everyone out there expects the USD to rise because they envision the Fed raising rates this year. A solid assumption. However, the pace and amount of increases will be to counteract the effects of anticipated inflation risks.

The Dollar erodes with higher inflation. During 2014 when we saw the dollar surge, it wasn't because the Fed was raising rates. To the contrary, the Fed didn't raise rates back then. One of the reasons the Fed remained on the sidelines was due to a significant decline in inflation expectations from about 2.5% to about 1.2% in that time frame.

If the economy continues to improve, and inflation expectations also start to rise, it could force the dollar to break lower, contrary to the consensus views out there. That wouldn't shock me at all.

Janet Yellen gave her testimony to Congress this past week and in her prepared remarks she spoke to the possibility of a March rate increase.

There were no surprises in Ms. Yellen's monetary policy testimony and the Fed chair did not provide any clues on the precise timing of future rate hikes. She didn't say a March move is a done deal, but did mention it would be unwise to delay further tightening as this would mean more rapid rate hikes down the road.

Sentiment

The current bull market is about to enter its 8th year, and we still haven't seen individuals turn bullish on stocks. If a rally from S&P 666 to S&P 2,300+ over 8 years isn't enough to draw them back in, I am not sure what will. Skepticism abounds. At this point, it looks as if the only remedy is going to be time, and it's not going to be measured in months. Changing sentiment is a process not an event.

When it comes to market sentiment, the latest data from AAII shows the same picture that has been in place for a while now. Bullish sentiment this week came in at 33.09%. This is the fifth straight week that bullish sentiment has been below 40%, and the 111th straight week that bulls have failed to take a majority. This is the longest sub 50% run in bullish sentiment in the history of the AAII survey.

Given the fact that all of the major indices are at all-time highs, one would expect a little bit more conviction. The prior record for the longest streak without a majority of bulls was from the start of 1993 through early 1995. During that period, the S&P 500 generally traded in a range with an upward bias where the S&P 500 rose 11.8%.

I am sure the very first time bullish sentiment does reach 50%, the cries of euphoria will be heard everywhere. Here is the takeaway about sentiment that everyone needs to understand. In the past when bullish sentiment finally did exceed 50%, equities surged with the S&P 500 rising over 14% in the next six months.

So when we come to the day when sentiment does finally rebound, it won't mean the end to the bull market. It will mean the euphoria stage has just begun and there will be more room for upside in the markets. The individual investing public will then get excited about equities and chase after what savvy investors and institutions own. That will be the first sign that it might be time to lighten up. How far the market goes before that develops is anyone's guess. My guess is that it could take a lot of time and the S&P could be a lot higher than where the market stands today.

That cycle has played out many times in my investing career and this time around will prove to be no different. Following the words in the opening quote, my experience tells me that and I have the confidence to use that to my advantage.

Crude Oil

The barrel police are doing their job. The IEA reported that OPEC compliance on the production cut agreed to last year averaged approximately 90% in January. The entire compliance issue is met with skepticism, I would rather ignore the commentary on the topic and let the price action dictate where I believe prices are headed.

WTI closed the week at $53.35 down $0.50. The commodity has traded in a narrow range in the last month or so and remains above the all important $52 price level.

The Technical Picture

I am amazed how the pundits are talking the correction scene as if it is something to fear. If one has been involved in the bull market and has been long, there is NOTHING to fear. Yet that talk dominates the airwaves. The S&P is up 10% since the first breakout in 2016. Five straight record closes for all three major U.S. indices only happened two times in history, at some point giving some of that back is healthy.

See It Market suggests that a pullback is near and sees exhaustion setting in next week. Given what has taken place in the last few weeks, it is a plausible assessment. And I reiterate that it is something to be expected and not to be feared.

The S&P 500 has closed at least 2 standard deviations above its 50-day moving average for three straight trading days indicating an overbought state. However, that doesn't necessarily mean the market is about to plunge or that this streak will end badly. We saw this same pattern during 2013, and more similarities to that time period are presented later. Shallow pullbacks yes, market plunge, no.

Meanwhile, breadth has been tracking price step for step in the last year, indicating nothing underneath the surface to suggest that internals may be weakening to give us pause.

Source: Bespoke

Another indicator to that is an important factor to consider is the number of stocks making new 52-week highs. In early 2016, when the S&P 500 made a new low, the percentage of stocks making new lows contracted significantly from 36.9% of the index to 19.4%. This was a signal that sellers were getting exhausted. Ever since then, as the S&P 500 has rallied, the percentage of stocks hitting new highs has been expanding with each successive step higher.

Since the most recent leg higher began over the last several days, there has been a slight divergence in that we have yet to see an expansion in the number of new highs above 18%. That was the level recorded during the first breakout in 2016. Something to watch going forward in the coming days and weeks.

When indices push higher, analysts/pundits find fault with breadth, volume and whatever else they can conjure up. It usually means they have missed the rally. While all of these issues matter, and can't be dismissed, one also has to apply some logic and realize that it's rarely perfect in the markets. Many times the signals aren't a convenient black and white, but gray.

Another issue this week that bears watching, as the indexes made new highs but advances vs. declines were about equal.

One signal that is not gray is another Dow Theory buy signal that was generated this past week. There has only been one false signal from Dow Theory over the past 15 years and that was a false sell signal generated by the Flash Crash in May of 2010, and that was quickly reversed with a buy signal. Ignore these at your own peril. We saw multiple Dow buy signals all during 2014. It doesn't mean to buy or go all in at the very moment that they occur, it means prices have not yet peaked. Translation, buy any dip.

Chart courtesy of FreeStockCharts.com

S&P 2,321 that was cited last week as resistance was met, and it promptly fell along with the previous pivot at 2,305 which fell the week before. A more critical resistance pivot at S&P 2,336 was also put in the rear view mirror this week as well. I believe that upward breach is signaling the third leg of the secular bull market has indeed begun.

So far, the index has stopped at the lower end of my target range of 2,350-2,380 when it closed at 2,351 on Friday. I wouldn't be overcome with grief if that marks the reflection point that suggests a pullback ahead. This rally has been robust and caught a lot of people by surprise.

With that in mind, it is time to contemplate the idea that stocks could hit a modest air pocket near term. Short-term support is at the 2,336 and 2,300 pivots, with resistance now at 2,385.

Market Skeptics

Remember the days when all that was heard was the stock market would see its day of reckoning when the Fed stopped its QE program. Well, QE has ended and the chart below tells the story.

Central Reserve balances are down and the S&P is up 20% since the end of QE3. Many of the same crowd still blames the central bankers of the world for where the global markets are trading today. The data vigorously disputes their calls and has proved the Fed obsessed crowd wrong once again.

Individual Stocks and Sectors

Powered primarily by the rally in technology, the Nasdaq Composite has ripped to new highs week after week. That should come as no surprise. The common sense view put forth after the election was to own growth in a pro-growth environment. The Nasdaq Composite index is now up 30% over the last 12 months. The recent seven day winning streak along with the winning streak posted by the S&P now compares to the action in 2013. For those that don't remember, 2013 signified the beginning of the secular bull market. It does not signal weakness, but strength. Increasing the odds for future gains.

For those that are inclined to believe the rally is over completely, the Nasdaq one-year forward return following all instances in which it gained 30%+ over the past year is 7.48%. However, stocks don't go up in a straight line. After periods of big gains like we have just seen over the past year, expectations should be tempered a bit, and pullbacks expected to dot the landscape.

On an intraday basis, the index has not pulled back more than 1.65% from an intraday high this year. Bulls are enjoying the ride, but the index is looking increasingly vulnerable for at least some consolidation. That is not a reason to bail out unless one is a short term trader.

One strategy that investors should use now is to take a look at a position that is now an overweight in their portfolio due to a large increase in price. One example, Apple (AAPL). Here is the opportunity to cull some shares that were purchased at $90 or so. The 50% gain now is a good way to add a little cash. Apple is but one of many that are now in that category. Another way for the active investor to manage their portfolios now is to sell some upside calls against a position that may be stretched.

Also, be on the lookout for intraday price reversals. A stock that makes a new high during the day and closes lower. That is a sure sign that a particular run may be coming to an end and consolidation is ahead. These stocks are good candidates for a call writing strategy.

The skeptics always ask me how is it that you have cash while you are always investing and adding to positions. These examples answers that question. None of this should be taken as a call to raise a boatload of cash, nor selling Apple because it is overvalued, but a way to cull overweight holdings and keep positions in balance. Active investors can play this uptrend like a fiddle, utilizing those funds to initiate positions on pullbacks.

The Nasdaq Biotech index (IBB) broke above the 20-month moving average the week, when it closed at 294.35. A monthly close above 292 will signal a new bull market leg has started and the bear market that has plagued the index may well be over. Lingering negative sentiment may start to shift. Positive news flow in the form of good earnings and increasingly attractive valuations support a move higher over the course of the year.

Teva Pharmaceutical (TEVA) is a stock that has been mentioned in earlier articles. The shares have been an underperformer so far this year. It seems there was no end to the negativity that surrounded the stock. That may have come to an end as the company reported a solid earnings quarter, and raised forward guidance. I added shares in anticipation of a turnaround in 2017. The stock comes with a 4+% dividend yield, and this may be the first step in that turnaround.

Mylan (MYL), part of my 2017 playbook, has cleared initial resistance, is up 10% this year and can be considered on pullbacks.

Cisco Systems (CSCO), a long time favorite as a dividend growth stock, just broke out to a new 52-week high. There is stiff resistance at the $34 level. What may boost the shares is the latest earnings report where the company beat on both the top and bottom line. The dividend was increased again. Once the $34 level is cleared, there is literally no overhead resistance until the old 2000 highs. Today, the stock sells at 15X, with a dividend yield that is 3+%.

The U.S. equity market isn't the only market in rally mode these days. Last week the highlight was the synchronized global market rally was telling us something.

Source: Bespoke

As shown in the Global Index Screen above, the majority of global equity benchmarks have been in rally mode ever since the election. Of the 29 equity indices, Italy's FTSE MIB and China's Shenzhen Small Cap index are the only two currently trading below their 50-day moving averages, while 18 out of 29 are trading in overbought territory. One U.S index that doesn't get much attention is the NYSE composite and that has also recorded new highs.

Given the unusually low volatility we have seen, one would think that when these types of streaks without a 5% correction finally end, they end with a bang and on a bad note. Not so, Bespoke Investment Group tells us that only three of the prior 18 instances where such streaks ended wound up with a decline of more than 2%. The average decline was 1.4%. That can easily be explained. Since the long awaited pullback is still not present, those on the sidelines get more anxious. When they do they will be the first to step up and get involved. Depending on how this plays out that may add more fuel to the rally.

Therein lies the wrench in the works of those that still believe the market is old, tired and ready to quit. The acceptance stage will ensue at some point and add fuel to the third leg of this bull market. Investor attitudes and ultimately stock market price action will be formed in the months ahead based on that premise. How fast this occurs will determine whether the stock market falls back into a trading range or whether the recent upside move becomes more widely accepted and additional market highs are recorded.

The buzzwords these days from market pundits, politicians, the media, and many investors are "there is significant uncertainty from the new administration". Ladies and Gentleman, whenever change is in the air there is ALWAYS uncertainty. How that uncertainty is viewed and interpreted is the key to being successful in the markets or just muddling along.

Whenever change is proposed the initial human reaction is to ask questions. What will it do to this, and how will it impact that? Inevitably, the thoughts always lean to the negative because change contains unknown and unknowns conjure up bad thoughts. This negativity sounds intellectually seductive as the arguments always sound smarter, especially when they dovetail with our own worries. Don't fall into the overreaction trap.

My suggestion is to calm down. First and foremost, the seeds of this rally were planted well before the election. The data is there to support that statement. Secondly, all change isn't bad, but having a closed mind overrules that fact. Many freeze and do nothing, or worse yet make mistakes based on speculation. Preconceived notions have been pervasive in this bull market.

No matter how much evidence and confirming stock market action has taken place, the notion that all is very bad and will always be that way has cost those with that ill advised thinking a fortune. Emotions are what make us human. But the successful investors pair emotion with reason and that allows them to survive and profit handsomely.

The financial institutions have figured it out, and the price action in the S&P confirms that. The only question investors have to ask themselves is if they too have figured out what is going on. Ideology takes a backseat to building wealth in my book.

Best of Luck to All!

Fear & Greed Trader is an independent financial adviser and professional investor with 35 years of experience in all market conditions. His strategies focus on achieving positive returns and preserving capital during bear and bull markets and he has a documented track record of calling the equity market correctly for the 10+ years.

He is the leader of the investing group The Savvy Investor where he focuses on sharing advice to help investors avoid the pitfalls that wreak havoc on a portfolio during bear markets. Features of the group include: Macro updates 7 days a week, ETF selections, covered call writing strategies, and live chat 24/7. Learn More.