It Has Been a Great Year … It’s Hard to Expect Another?

DJIA:  36,398

It has been a great year … it’s hard to expect another?  The market hasn’t had more than a 5% correction in the last two years, can you expect another?  With inflation a serious practical problem for the first time in a generation, can you assume that still, “there is no alternative” for stocks?  Then there’s the taper.  In 2011, just hints from the Fed that it wouldn’t expand its asset purchase program preceded a 19% drop in the S&P.  In 2015 talk of a balance sheet shrinkage came before a 12% decline.  In 2018, a comment about balance sheet unwind on “auto pilot” coincided with the near death of the bull market.  On the technical front, while the averages are at or near highs, the average stock has lagged.  Less than half of NYSE stocks are above their 200-day moving average, that is, in medium term uptrends.  All these things leave us cautious.  It’s ironic that everyone likes to make predictions this time of year when this time of year itself often offers important insights.  It’s a good time of year to be observing rather than predicting.  Besides, the best prophet, Thomas Hobbes once wrote, is the best guesser.

The idea that we could see three rate hikes next year so far has left the market surprisingly undaunted.  Then, too, we’re more concerned about the taper than the hikes.  Monetary policy may only shift to merely easy versus extremely easy, but what counts is the change at the margin, rather than the absolute level of stimulus.  Mike Wilson points out the Fed will go from a $1.4 trillion annualized pace of asset purchases to zero in four months.  This reversal of the extraordinary fiscal and monetary stimulus applied to fight the pandemic almost certainly will have an impact on multiples.  Beyond the Fed’s massive securities purchases since March 2020, Felix Zulauf points to the largely unrecognized impact of the Treasury’s sharp drawdown in its balance at the Fed.  The reduction, which has injected liquidity into the economy, is about to reverse.  At the same time, China isn’t recycling its US dollar holdings as it used to, further reducing global dollar liquidity.  Seems a bit esoteric, but not really.  It’s at the core of technical analysis, that is, supply and demand.

When someone says they’re bearish, we always ask does that mean you own few or no stocks?  Invariably the answer is – well, we do own stocks, but …  If you are really bearish you own few stocks.  Investor sentiment peaked earlier in the year amidst the speculative binge around meme stocks.  Many of these stocks peaked back then as well, of course the averages did not.  As the averages have moved higher, speculative buying as measured by Call buying has surged a couple of times.  One sentiment measure that has remained unimpressed is the AAII Bull Ratio, a survey of, shall we say, more sedate investors.  The AAII Bull Ratio has held below 50% for five straight weeks.  When below 45% while the S&P is above a rising 50 week moving average, the S&P has gained 91% of the time over the next three months, according to  And this is only the second time since the inception of the survey the ratio was negative for the first four weeks of December.  A possible caveat, their talking the talk – survey shows respondents cautious, but with a high allocation to stocks.

The S&P healthcare sector has pretty much kept up with the S&P Index itself.  Biotech ETFs, however, are not even in the black this year.  The XBI, an Equal Weight Index which focuses on small and mid-caps, is down more than 20%, and more than 28% from its 2021 high.  And the median stock in the group is down 50%.  Recently, fewer than 10% of the stocks were above the ten-day average, fewer than 15% were above their 50-day average, and fewer than 20% were above the 200-day average.  All these are within a few percent of all readings historically.  This says washed out.  Then, too, washed out is one thing, new uptrends can be another.  If washed out, the IBB (154) and XBI (113) should do something right, as we like to say.  For both, that would be a move above their respective 50-day averages.  For IBB, that would be above 156 which also would break the downtrend in place since September.  The XBI has broken the downtrend, but remains below the 50-day around 120.  A new wave of M&A could serve as a catalyst here.

Historically, it has been difficult to bring inflation under control unless interest rates rise to the point they’re above the rate of inflation.  That’s should mean lower bond prices.  The money out of bonds could flow to gold, not crypto, as an inflation hedge.  Bond prices have turned down, gold prices seem undecided.  In an inflationary environment oil should have another good year.  The spread between Staples and NASDAQ stocks in terms of their 50-day averages, 90% and 25%, respectively, is the most in 30 years.  We believe in Staples but leadership in the New Year is often unclear – back to observing versus predicting.  Insiders stand selling – assuming they know value, it’s not a good sign.  Tesla (1070) may be the greatest new economy stock but when the founder starts selling, for whatever reason, it doesn’t seem a good thing.  Like this year, where you’re in likely will be more important than whether you’re in.  Generally speaking, we like stocks in long-term uptrends regardless of their group or industry. An example we haven’t mentioned before is Prologis (168).  Meanwhile, with a divergence already in place, the Advance-Decline numbers will remain important.

Frank D. Gretz

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Sure it’s the End of the World … But We Think it’s Discounted

DJIA:  35,897

Sure it’s the end of the world … but we think it’s discounted.  A hawkish Fed is not the end of the world, and we do think it is discounted – at least it should be.  If you didn’t know it had become a more hawkish fed, you have to be under that proverbial rock.  And when it comes to the stock market, what we all know isn’t worth knowing – it’s discounted.  Sure the market could have reacted negatively to the meeting, after all, you never know.  But having sold off in the days prior to the meeting that seemed unlikely.  And the market could have taken the bad news as the bad news it really is, but that’s on the market – the market makes the news.  Half the news in a bull market is bad news but the market ignores it.  That the market seems to have ignored this particular bad news is a good sign, at least for now.  But it is bad news.  Don’t fight the Fed, and all that.

We first became involved with the technical analysis for a simple reason – we noticed when “the market” went up we made money, and in market corrections we lost money.  We decided a better understanding of what moves markets might be helpful, so we enrolled in the Bob Farrell school of technical analysis.  We’ve become somewhat proficient at recognizing market trends, not so good at recognizing their duration.  In any event, we believe things have changed, in part at least because of the significant degree of passive investing.  Back in the day market trend was most important – academic studies showed the overall trend accounted for as much as 50 to 60% of the movement in any individual stock.  Group performance was another 20% and fundamentals the rest.  We’ve seen no recent academic studies, but our take is those numbers may well be reversed.  Group behavior now seems to dominate.  Where you’re in has become more important than whether you’re in.

Tech has been the place to be this year, as it was for much of the 1990s, but it hasn’t always been that way.  Consumer stocks dominated the 1980s and back in the 1970s when inflation ruled, it was mining and energy stocks that performed well.  Coca-Cola (59) sold for 40x earnings in 1972 and only 9x earnings in 1981.  Had you bought Coke at the end of 1972 – a real buy and hold stock – you didn’t break even until 1985.  Leadership in the stock market does change, and we think an important one likely has begun.  We’re not saying sell your Apple (172) and Microsoft (325), but “multiple of sales” Tech is likely to lose out as consumer staples stocks likely continue to outperform.  Of the 33 stocks in the XLP (77), the Consumer Staples ETF, 10 have very positive charts – PepsiCo (172), CVS (101), Hershey (192), Procter & Gamble (161), Estee Lauder (363), Costco (533), you get the picture.  As for XLP itself, it has cycled from fewer than 5% of component stocks above their 10 day average to more than 95%.  That typically signals the start of an important move.

Aside from being in the right groups or sectors, the easiest way to make money in stocks is to be on the right side of the trend.  In this case we’re talking about the long-term trend.  Many claim to be long-term investors, yet they own stocks in long-term trading ranges.  You don’t need to predict here, just look for stocks in five year steady uptrends.  Those trends tend to persist.  And when your timing is a little off, the trend bails you out.  There are ample examples even in consumer staples, including Pepsi, Costco and Procter & Gamble.  Two others that qualify here are Accenture (401), which gapped higher Thursday, and Intuit (634) which is consolidating.  Even for those of us who don’t know the meaning of “long term,” trend is important.  The easiest way to make 50% trading is to trade stocks in the process of doubling.

In November the market worried inflation was out of control, now the market is worried the Fed will be out of control.  Despite the apparent demise of Evergrande, still no worry about China.  And still no worry about Russia and the Ukraine, though we keep checking those defense stocks for a sign.  It seems doubtful that financial conditions can tighten without some sort of market accident, and the technical back drop has begun to bear that out.  The A/D Index peaked in early November, this measure of the average stock typically does so well before the averages themselves.  More importantly, with fewer stocks advancing and in uptrends, it has become even more difficult in this already difficult year.  The for sale sign on most of Tech here at year end may seem a dirty trick, but more likely is simply about crowded trades.  And, did we mention, leadership does change.  Meanwhile, with the Fed worry out of the way, we expect the market for now to muddle through, including Tech.

Frank D. Gretz

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US Strategy Weekly: Monetary Policy Shift Ahead

This week could be pivotal for equity investors since the December Federal Reserve Board meeting is expected to result in a well-telegraphed reversal in monetary policy. The details and timing of quantitative easing and interest rate changes will be most important. Quantitative easing is expected to slow, perhaps more quickly than previously thought, but reversing QE has rarely had a negative impact on equity trends. The crucial part of monetary policy is the raising or lowering of interest rates. History shows that three or more fed funds rate hikes within a 12-month period has been followed by equity declines. The faster the rate hikes are made, the bigger the negative affect on the stock market. Therefore, the real focus this week will be on Chairman Jerome Powell’s comments and the possible timing of interest rates increases.

Unfortunately, we believe the Federal Reserve is already behind the curve. More importantly, one could opine that the current wave of inflation is man-made. A combination of historically large fiscal and monetary stimulus during an economic recovery is a perfect recipe for inflation — as any basic economic textbook would attest. Ironically, this was ignored by most economists, politicians and surprisingly by the Federal Reserve. And though equity investors have ignored soaring inflation numbers for months, recent data has made it more difficult to ignore. In our view, by ignoring inflation, the Fed has allowed it to become more embedded in the system. As a result, it could take more rate hikes to reverse than if it had been addressed earlier this year.

November’s inflation numbers were disconcerting. Headline CPI rose 6.8% YOY, the highest pace since the 7.1% YOY recorded in June 1982. Core CPI rose 4.9% YOY, the highest since the 5.0% pace in June 1991. See page 6. Headline PPI rose 13.3% YOY, the highest since October 1980. Core PPI, excluding food & energy, PPI jumped 5.9% YOY, the highest since March 1982 and final demand PPI rose 9.7% YOY, the highest on record. In other words, November’s inflation was the highest in thirty years which means many of today’s young investors have never dealt with inflation or understand its many repercussions.

Rising prices have spread throughout the economy and although fuel prices are no longer the main driver of US inflation, energy remains one of the most important triggers for future inflation. The good news is that WTI crude oil prices are down 16% from their October 26 peak of $84.65. The bad news is that WTI is still up 46% year-over-year. Gasoline prices are down a similar 16% from their high of $2.52 also made on October 26. See page 10.  

As we have discussed in previous reports, inflation of 4% or more tends to have a deleterious impact on price earnings multiples. For this reason, it is not surprising to see that many large capitalization technology stocks have encountered selling pressure this week. Technology stocks tend to have high multiples which become a high-risk asset as inflation rises. Also note that the following ten stocks in the Nasdaq 100 composite index represent 63% of the total market capitalization of the index and a significant percent of the S&P 500. During market weakness, or whenever selling pressure creates a liquidity crisis, large cap stocks become the most liquid and therefore bear the brunt of selling pressure.

We believe the best strategy for the next several months is avoid high PE stocks and tilt toward stocks with predictable earnings streams, modest PE multiples and dividend yields greater than the current 10-year Treasury bond yield of 1.4%. The recent gains in the consumer staples sector are an example of this transition. We expect a better buying opportunity for large cap technology stocks will appear in the first half of 2022.

Households Balance Sheet and Sentiment

US household net worth rose 1.7% in the third quarter to a record $144.7 trillion, which was an impressive 10.5% increase year-to-date. During the quarter, nonfinancial assets rose 3.7% and corporate equities fell slightly. Year-to-date, nonfinancial assets rose a sturdy 11.7% versus 15.7% for equities. Equity assets directly held by households, versus indirectly through pension funds for example, rose 18.6% in the first nine months of the year. However, household real estate gained 11.4% this year to date, and owners’ equity in real estate rose an impressive 14.7% in the first three quarters reaching 68.8%, the highest level since 1988! This suggests many households benefited from a rise in residential real estate values in 2021. See page 3. It may also explain why Christmas shopping appears to be setting a record this year.

However, Fed data on household balance sheets has also shown that when equity ownership exceeds real estate values, the equity market is at risk. This is true currently. Moreover, in June, equities represented 41.5% of total household financial assets and 29.4% of total assets. Both were new record levels that exceeded the previous peaks recorded in early 2000. In short, equity ownership may be reaching an over-owned condition, and this implies caution. See page 5.

Good news in net worth did not translate into an improvement in consumer sentiment. December’s preliminary consumer sentiment from the University of Michigan showed small gains in the index, yet the survey lingers only modestly above the 2021 lows. The NFIB small business index edged up 0.2 points to 98.4 in November, but most parts of the survey were little changed. On the other hand, the outlook for general business conditions worsened to negative 38, matching its worst level seen November 2012. All in all, soaring inflation appears to be taking a toll on businesses and consumers. There has been little change in technical indicators this week. The 10-day average of daily new highs fell to 82 this week and daily new lows are at 186. This combination — with new lows over 100 per day — was downgraded from neutral to negative last week. The NYSE advance/decline line’s last record high was on November 8, 2021, and it is trading well below this level currently. Volume has been rising on down days and slipping on rally days, which is a worrisome combination. See page 13. The 25-day up/down volume oscillator is at negative 2.5 and approaching an oversold reading which would be a negative omen. And finally, the Russell 2000 index continues to trade below all its moving averages which could be a sign of a trend reversal. All this points to the need to be cautious as 2022 approaches.  

Gail Dudack

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No Cigar … But Close Enough?

DJIA:  35,754

No cigar … but close enough?  Not every sell-off ends in a real washout, and this one did not.  Still, this seems a credible low.  Certainly the decline had its moments, including a couple of near 90% down volume days, important when you consider sellers, not buyers, make lows.  Lacking was an 80% up day or a 5-to-1 A/D day, achievable when sellers are out of the way.  Somewhat ironically, rather than momentum numbers it’s the sentiment or psychology side that says low.  The surge in the VIX (21) and subsequent reversal says there was panic, and it has now ended.  In a complete turnaround, the extreme Call buying turned to Put buying to the highest degree since the pandemic rally began.  And inverse ETF buying, today’s equivalent of short selling, reached 2.2% of NYSE volume, the most ever.  So no washout low, but likely one good enough for now.

The market pretty much played doctor to start Monday’s 600 point rally.  While we didn’t hear anyone screaming the variant is not a problem, the market did just that – the vaccine stocks tanked and oil stocks surged.  This was, of course, just the opposite of the 900 point drubbing a week or so ago, when the markets seemed to be saying all was lost.  Markets are not always right and may not be again this time.  At least they are a reasonably fair game, and the market gets it right more often than most of us.  Hence, our predilection for observing and keeping the predicting to a minimum.  You didn’t have to predict the little correction we’ve been through, you just had to observe the S&P and NASDAQ dancing around their highs while the A/Ds were negative for seven consecutive days – that never ends well.  Even now those numbers will be important.  You don’t want to see strength in the averages against the pattern of weak or negative A/Ds.

Leadership this year has been fickle, to put it kindly.  For the most part there has been a division between stay or go, stay at home or don’t stay at home.  Of late there seems another division within stay at home – don’t get on an international flight or a cruise ship, don’t get on your Peloton but by all means go to McDonald’s.  And what does it mean when MCD (262) is acting better than Microsoft (333)?  Fortunately we’re not afflicted with the problem of figuring out why things are as they are, we just know when they are what they are.  Our two cents, and you get what you pay for, we could be about to see a shift away from stocks selling for a multiple of sales back to stocks selling for a multiple of earnings.  We are not suggesting you sell your Microsoft, but it may be time to take a hard look at stocks like McDonald’s or a Procter & Gamble (153), stocks where the long-term trends resemble that of Microsoft.

This time of year everyone tends to chomp at the bit to predict next year’s returns.  Interesting when you consider few predicted even the recent little setback, and when the start of the calendar year is often a predictor of how it will end – the old, as goes January thing.  Undaunted, and interesting for the call, are predictions of a negative return from institutions as big and influential as Morgan Stanley and B of A, both of whom it would seem have a vested interest in seeing prices higher.  Their concern is inflation and, therefore, rising rates.  As suggested above, we’re not fond of predictions and will wait to see how the now lagging Advance-Decline Index plays out.  Were we to venture on the dark side of funnymentals, it’s not hard to see trouble next year.  Rates seem headed higher, and “don’t fight the Fed” works both ways.  The real worry seems consumer sentiment where the numbers peaked earlier in the year.  They have an excellent record of preceding downturns.

After major declines, stocks bottom together – when the selling is done, it is as though there’s a vacuum on the upside.  Tops are completely different.  Stocks/groups peak a few at a time, typically the big first and, therefore, the divergences between the averages and the A/D Index.  Typical as well, speculative areas peak early.  Where did all those SPACS go, let alone those MEME stocks?  Certainly controversial and certainly an area of speculation is bitcoin.  We’re speaking here of the surrogate equities, like Riot Blockchain (26), Marathon Digital (41) and Coinbase (264).  We know they have survived this look before, but the charts here are not pretty.  As for the market, if the Fed meeting next week is as hawkish as expected, will that be a surprise?  Another time when the market will make the news, and a time to not predict but to observe.  Thursday was one of those bad up days of sorts, Dow flat, A/Ds 3-to-1 down. That’s not gonna get it done.  Down days happen, bad up days are a problem. We seem out of the woods, but watch those A/Ds.

Frank D. Gretz

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US Strategy Weekly: Technical and Economic Update

Technical Indicators Revisited

Last week we focused on the technical condition of the US equity market since a number of macro indicators were at borderline negative readings and were exposing a rise in marketplace risk. This week we find little resolution in most of these indicators. For example, the 25-day up/down volume oscillator has ratcheted up to negative 1.23 after nearly falling into oversold range; but its rebound is minor and inconclusive. See page 12. On the other hand, the 10-day average of daily new highs fell to 68 this week and is well below the 100 mark that defines a bull market. Simultaneously, the 10-day average of daily new lows rose to 247 and well above the 100 level that defines a bearish market. Last week we downgraded the moving averages of new highs and lows to neutral and this week it is downgraded to negative. See page 13.

Less decisive is the NYSE cumulative advance decline line, which is well off its high made on November 8 even though the S&P 500 is only 0.4% away from its November 18 record high. Total NYSE volume continues to be slightly above average on down days and just below average on rally days which is also an ominous trend.

Not surprisingly, there is quite a bit of disparity in the performance of the popular indices. The S&P 500 and Nasdaq Composite index are the strongest benchmarks and appear to be successfully rebounding from tests of their 50-day moving averages. This looks positive. The Dow Jones Industrial Average is slightly less strong and appears to be rebounding from a test of its 200-day moving average. However, the Russell 2000 index continues to trade below all three of its moving averages, and even after its advance of 3% on December 7 remains in the middle of the trading range that contained prices for the first eight months of 2021. The Russell 2000 index had a false breakout in November and is now showing a surprising level of weakness. All in all, the action of the Russell 2000 is more in line with the trend seen in the NYSE advance decline line. See page 11.

The difference in the indices is easily explained. The S&P 500 and Nasdaq Composite are heavily weighted in the largest popular technology stocks which include Apple Inc. (AAPL – $171.18), Microsoft (MSFT – $334.92), Amazon (AMZN – $3523.29) and Alphabet Inc. (GOOG – $2960.73). Once the Omicron virus was discovered these stocks became increasingly volatile and have been driving the performance of the S&P 500 and Nasdaq Composite index.

The Dow Jones Industrial Average is only 30 stocks, but it is not market cap weighted and is more diversified in terms of sector representation. In general, it has been slightly weaker in terms of price performance. Since it includes 2000 stocks, the Russell 2000 is a far broader representation of the overall market, and it has been the worst performing index in recent weeks. In sum, the underlying tone of the equity market remains suspect, and we would recommend holding quality stocks that can weather the volatility that is apt to continue through year end.

Economic Data Shows Growth but Too Much Inflation

The unemployment rate fell to a 21-month low of 4.2% in November, but the headline jobs report was a disappointment with an increase of only 210,000 jobs. On the other hand, the household survey which includes many more categories of “workers” such as agricultural employees, unpaid household workers and entrepreneurs, increased by 1.1 million jobs. This was an unusually wide disparity between the two surveys, and it may signal an upward revision to job numbers next month.

Another oddity in the household survey was that the number of people unemployed (see page 3) declined twice as much as the number of newly employed workers. This is a sign that people are leaving the workforce and it clarifies why the participation rate has been so slow to improve this year. The question is why are people leaving the workforce? Are more aging baby boomers retiring? Are working mom’s choosing to stay home? Has COVID inspired an increasing number of people to become independent entrepreneurs? Any or all of these possibilities may explain why fewer people are now included in the official workforce. However, the answer to these questions could point to when employment might finally fill the gap of 4 million workers lost between the February 2020 peak and November’s job report. See page 4.

Both the non-manufacturing and manufacturing ISM indices improved in November and the surveys showed solid increases in production and employment. We found it interesting that both surveys revealed a slowdown in the backlog of orders and in exports. See page 5. Some of this may be due to unresolved supply chain issues or it could be an offset to October’s record high exports. But it could also indicate that orders and business activity slow whenever COVID-19 cases begin to rise. For example, Europeans are currently protesting new strict regulations aimed to curb a rise in cases in many countries in Europe.

November’s Conference Board Consumer Confidence fell to its lowest level since February 2021. The main University of Michigan consumer sentiment index fell to its lowest level since November 2011, due in large part to the present conditions survey which at 73.6 is the lowest since the 68.7 recorded in August 2011. See page 6.

We believe the declines in consumer sentiment can be explained by the discovery of a new COVID-19 variant and the personal income report for October. Personal income rose nearly 6% YOY in October to $20.8 trillion and disposable income rose 4.1% YOY to $18.1 trillion. However, real personal disposable income fell 1.4% YOY to $15.4 trillion. This was a result of a 6.2% YOY rise in inflation and a 20% increase in personal current taxes. See page 7. In other words, purchasing power of households is declining. More importantly, in October, personal taxes equated to 12.9% of personal income, the highest percentage since late 2001. What concerns us is that sharp rises in taxes as a percentage of income have often been followed by recessions. See page 8. Monitoring taxes as a percentage of total personal income can help explain how fiscal policy impacts households and how, if not done wisely, policy can inadvertently trigger a recession. Another factor in terms of a weakening in consumer confidence is that the savings rate fell in October from 8.2% to 7.3%. This is notable since 7.3% is well below the long-term average rate of 8.9%. Crude oil prices fell 22% during the month of November but are still up 43% year-over-year. Hopefully the decline in crude oil prices will ease some of the pressure felt by the household sector as a result of rising gasoline and heating fuel prices. At the same time, this sell-off in oil raises the specter of weakening global economic activity. Stagflation could bring even more pain to investors in 2022.

Gail Dudack

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Don’t Blame the Covid Variant … Blame the Technical Variant

DJIA:  34,639

Don’t blame the Covid variant … blame the technical variant.  Blaming the weakness on the technical background seems a bit of a stretch, but not as much as you might think.  Against the backdrop of the S&P and NASDAQ dancing around their highs, NYSE declining issues outnumbered those advancing for seven consecutive days.  That’s a pattern that almost always leads to trouble.  Throw in the recent over the top Call buying, and risk increases all the more.  The Covid variant didn’t cause the weakness, it was instead an excuse for the weakness.  Similarly, Powell’s testimony Tuesday was yet another excuse for the day’s decline.  What is ignored in good markets gets punished in technically weak ones.  It’s the market that makes the news.  The market needs to get to the point where bad news is no longer bad.

Hindenburg is back, the omen that is.  Scorned for its name, the indicator is as useful as most.  That’s because the premise is sound.  Markets internally out of sync are not healthy, and are a warning.  Divergences between the market averages and the Advance/Decline Index, for example, mean the large-cap stocks that dominate the averages are out of sync with the average stock as measured by the A/D Index.  The Hindenburg rather than looking at A/D’s, looks instead at 12 month new highs and new lows.  It’s not whether one is greater than the other, it’s when in an uptrend they are more or less equal. That’s a market divided, and you know how that saying goes. That equality in new highs/new lows took sides last week.  On the NYSE new lows were more than double the number of new highs and more than triple on the NASDAQ.  This speaks to the almost superficial aspect of the strength in the averages.

As a result of the above the market has narrowed.  In the process the Russell 2000 has forfeited its break out which had been so encouraging.  After some seven months of literal hibernation this measure of secondary stocks joined the S&P/NAZ party in late October and, as the chart shows, did so in dramatic fashion.  Now back below the breakout point, the rule of thumb says sell half, it’s unlikely it will work.  By the way, this applies to individual stocks with similar patterns.  The other part of the story here seems big is where you want to be.  It’s not the most healthy thing for the market, but it is what it is.  And when it comes to big, big Tech seems the place to be.  They held together in the heart of the pandemic, and by the look of Apple (164), Microsoft (329), and the semis, seem likely to at least outperform.

Cathie Wood of the ARK ETF fame has had a tough go of it this year.  So much so that new on the scene is the Tuttle Capital Short Innovation ETF (SARK-37) – payback time for the Everly Brothers.  The object of the ETF is to mimic ARK Innovation (ARKK-99) inversely.  After knocking the cover off the ball last year, Cathie has been a little out of sync this year, but who among us is without our rotation faux pas.  What is a bit troublesome here is that she seems to lean to “stay at home” stocks, like Zoom Video (192), Teladoc (97), Roku (210) and the like.  Come what may with the new variant, we don’t see anything like the previous lockdown when those stocks were big winners.  And the charts more than bear that out, as does the chart of ARK Innovation itself – and this despite a 10% holding in Tesla (1085). With its stay at home emphasis, news of the variant helped the fund last Friday, but that proved brief.  The variant doesn’t seem to be helping ARKK, its going away likely also wouldn’t help.

We have seen a couple of days of extreme selling – near 90% down volume days.  That’s a good thing when you understand sellers, not buyers, make lows.  Prices can move up with relative ease when selling is out-of-the-way.  You do need proof of that, however, like an 80% up volume day.  The spike in the VIX (28) is also encouraging, but it’s not the level per se that counts.  What is needed is a reversal from a high-level to indicate the panic has passed.  With fewer than 6% of S&P issues above their 10 day average, a rally of sorts was due.  THE low seems doubtful, but a big up day would change our mind.  They say never buy an up opening in a bear market.  Wednesday’s opening and dramatic reversal argue for a bear market.  Thursday’s up opening and decent close argue – never mind.  We expect this year to muddle through, talk of bear market possibly is next year’s story.

Frank D. Gretz

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US Strategy Weekly: Powell’s About-Face

We are not surprised that Federal Reserve Chairman Jerome Powell changed his view that inflation is transitory or that monetary policy would not change dramatically in the foreseeable future. However, we are surprised that he would make an abrupt about-face in his views less than two weeks after being reappointed as Chair of the Federal Reserve!

This week the Fed chief told members of the Senate Banking Committee that the word “transitory” should be retired when describing inflation. In terms of monetary policy, he added that the Federal Reserve “at our next meeting in a couple of weeks (is) going to have a discussion about accelerating that taper by a few months.” The fact that monetary policy may be changing more quickly than popularly expected spooked the market. But in our view, what is more disturbing is that the FOMC waited too long to address inflation and as a result, its delay in reducing monetary ease earlier this year means it will be forced to raise interest rates more often and higher in 2022 than if they had started a shift months ago. This is the crux of the issue, and it is what has investors worried.

Unfortunately, Powell’s comments came on the heels of another troubling event. On Thanksgiving Day, reports surfaced from South Africa indicating a new COVID strain known as Omicron had emerged in a number of southern African countries. The World Health Organization warned it was a “variant of concern” and European countries banned travelers from eight African countries. President Joseph Biden announced similar restrictions on Friday. The thought of another bout of restrictions compounded the list of unknowns facing the financial markets and this combination triggered a sell-off.

As we noted last week, we put little value on the market’s performance on the Friday after Thanksgiving Day. It is usually the lowest volume day of the year; many traders are on vacation and investors are also distracted. This combination can create a lot of volatility, but nothing meaningful in the longer run. In other words, the 905-point decline in the DJIA on November 26 was dramatic but did not carry great weight in our view, even though declining volume rose to 89% of total volume. But the rebound on November 29 which boosted the DJIA 236.6 points was indeed a concern. Volume rose in the session and was well above the previous 10-day average, yet despite the gain in the index, volume in advancing stocks was only 50% of the day’s volume while volume in declining shares represented 48% of the total. This was not impressive. However, volume on the 652-point decline in the DJIA on November 30 was more than twice the 10-day average. See page 12. In short, although the S&P 500 is less than 3% from its record high of 4704.54 made on November 19th there are a number of changes in the landscape in the last three trading sessions. Several technical indicators are on the verge of turning negative.

One of the signs that the market is at risk in the intermediate term is seen in the chart of the Russell 2000 index. We have focused on this chart for months since it is broader than the SPX or DJIA and less influenced by the action of large cap technology stocks. The RUT underperformed for most of 2021 but broke out of an 8-month trading range in early November creating a very bullish chart pattern. However, in the last four trading sessions this breakout has reversed into what appears to be a breakdown. The RUT (2198.91) is now trading in the middle of its 8-month trading range, but it has dropped below its 200-day moving average of 2260.12. In short, it appears the early November rally in the RUT was a rare, but troubling, false breakout. See page 10.

Another technical indicator showing erratic behavior is the 10-day average of daily new highs and lows. The new high list has been consistently bullish in 2021 and the 10-day average reached a high of 368 in early November. Nonetheless, the average number of NYSE new highs in the last three trading sessions fell to 45 and the 10-day average dropped to 144. This is still above 100 and positive. But the number of new lows rose to 390 on November 30 and the 10-day average is now 206. This is well above 100. Since 100 new highs or lows defines the major trend, one can see that even with highs and lows currently averaging more than 100, the action of last few trading sessions is suggesting a major shift may be taking place. One should observe, not predict, the indicators, but the underlying trend is beginning to favor the pessimists.

Technical analysts take note of 90% volume days because these extremes tend to represent investor panic. Panic selling tends to start slowly, accelerate, trigger margin calls, and then turn into a short, but painful liquidity crisis. This multi-stage pattern often characterizes a major market trough. Panic buying has less predictive value, but 90% up days following a major sell-off frequently marks the end of a bear cycle. In recent days we have recorded an 89% down day on November 26 and an 88% down day on November 30. Neither quite met the criteria for a panic day; however, the combination did result in the 25-day up/down volume oscillator tumbling to negative 2.62 this week. It is close to recording an oversold reading of negative 3.0 or less. An oversold reading that follows a series of record highs in the indices that failed to record significant overbought readings, would be a sign of a major shift in trend. We will be monitoring this indicator closely in coming sessions. See page 11.

Given the weakness in the market this week we reviewed margin debt data, since sharp price declines can trigger margin calls and intensify selling pressure. Margin debt totaled $935.9 billion in October, up 4% for the month and up almost 42% YOY. As a percentage of total market capitalization, margin debt was 2.03% in September, matching the January 2014 level. It should be noted that the 2014 stock market did not have any major corrections but prices did fall nearly 10% from a September high to an October low. Yet with our estimate for October market capitalization, this ratio edged lower in October.

As a percentage of GDP, margin debt hit a record 3.93% in September. This ratio is a less meaningful measure than margin debt to market cap, but it does suggest that the level of leverage in the system is high. Our favorite indicator uses margin debt to help identify when a leveraged price bubble is about to burst. We have found that when margin debt is increasing at an unusually fast pace and this leverage is not moving the market indices in equal measure, it is a sign of exhaustion. This is the 2-month rate-of-change (ROC) index. A reading of margin debt growing at 2 standard deviations (15.3%) or more, without a similar reading in the Wilshire has marked significant market tops in March 1972, March and June 1976, June 1983, December 1999, June 2003, and May 2007. The good news is that this indicator is now neutral. See page 7. Last, but far from least, the chart of WTI crude oil (CLc1 – $66.18) has declined 20% along with stock prices but is still up 48% YOY. WTI has now dropped below its 200-day moving average and although there is substantial support in the low $60 area, the uptrend from the 2020 low is at risk. This sell-off will ease some of the pressure the household sector has experienced from increases in gasoline and heating fuel prices. Nevertheless, this sharp fall in energy prices does raise the specter of stagflation which is a scenario that could bring even more pain to investors in 2022. In sum, there are signs that the major trend in the market could be shifting, and this emphasizes the need for quality stocks that can overcome the forces of either inflation or a weakening economy.

Gail Dudack

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