Underlying Fundamentals … Way Under is How Some Would Seem

DJIA:  38,905

Underlying fundamentals … way under is how some would seem.  With all due respect to companies like Nvidia (879) and Super Micro (1130), underlying fundamentals don’t drive those kind of straight up moves.  Moves like that come about when at some point investing turns to trading – when stocks are bought not so much for the companies they represent, but simply because they’re going higher.  Let’s not pretend GPUs are any more important than routers back in 2000, or that either are really understood by most doing the recent buying.  And let’s not pretend there’s ever been a shortage of anything that hasn’t been met.  As for Bitcoin, it’s a position we like for exactly that reason.  After all, what do we know about Bitcoin.  We do know, or hope we know the passive ETFs seem likely to drive Bitcoin just as they have FANG/AI.  At least when you buy one of the FANG/AI ETFs you may be buying 10 stocks, with the Bitcoin ETFs you’re getting just one thing.

Meanwhile, a correction remains the proverbial watched kettle.  Last Friday one seemed more likely when Nvidia reversed and took the market with it.  Indeed, Nvidia had what those technicians call an outside day down – higher high and lower low than the previous day on a bar chart.  It’s a “reversal” pattern but not one we find terribly useful.  Nvidia’s cohort of sorts Super Micro, had an outside day down Feb 16, and was back to its highs three days later, and from there onward and upward.  Certainly there is a correction of sorts when you consider something like the MicroSectors FANG+ ETF (FNGU-311) has gone nowhere for six weeks now.  Markets and stocks also correct by going sideways rather than down.  The main consideration here is that on average this has not hurt the overall market.  And that’s what matters.

While Bitcoin gets all the attention of late, in its corner Gold is quietly making new highs.  After several failures over the past four years Gold’s new high seems promising though, after all, it is Gold we’re talking about here – and its history of false dawns.  And on a cyclical basis, Gold is in one of its four year down-cycles which persists through the end of this year.  Together with Bitcoin’s performance, it’s easy to argue there’s a real interest in investments seen as a store of value, a hedge against currencies and the establishment generally.  A look at the weekly chart of the SPDR Gold ETF (GLD-200) which holds Bullion, pretty much says it all.   While the miners have lagged, they have moved from having only 5% above their 200-day to 20%, a change that has seen higher prices since 1997, according to SentimenTrader.

Things act better, by things we mean stuff other than the esoteric stuff like AI.  It’s true of Oil but most dramatic here we’re thinking of Copper, at least as measured by the ETF (COPX-41).  When we see this, in our simplistic way we think China is rebuilding – again.  And the Chinese market does seem to have a turn.  Or perhaps more simply the world economically is a better place.  Of course stocks like Grainger (992) with their division called “endless assortment” and Fastenal (75) with their very techy nuts and bolts have been telling us that for a while.  If there’s a bubble in parts of the market, this is why it’s not a market bubble.  Bubbles occur in segments or sectors of the market and end when only they are moving higher.  Back in 2000 the dot-com’s were going up and everything else was going down.  This market is different.

Most days most stocks go up, but Thursday wasn’t one of them.  With some 3000 stocks down on the NYSE it wasn’t close.  Like most such days blame the usual suspect bonds/rates.  Bad down days happen.  It’s the bad up days – poor A/Ds and the Averages up – that are the worry.  Lacking virtually any divergences, a setback here should prove temporary.  The worry is that in any recovery the A/Ds don’t quit on us.  While Regional Banks held together almost surprisingly well in light of the NYCB (4) news, it may be premature to say all is well.  Tech seems everyone’s worry and yet most held together Thursday.  Meanwhile, abetted by Tuesday’s CPI print, the Fed’s message was that it wants to cut, but doesn’t think the data will allow it.  The market’s lack of disappointment here likely stems from the fact cuts are coming, and corporate profits in the meantime are just fine.  Of course, higher prices do much to dampen worries.

Frank D. Gretz

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US Strategy Weekly: Bitcoin, Equities, and ETFs

Bitcoin (BTC= – $63,770.00) touched a record high this week based on a view that global interest rates will soon fall. In many ways, bitcoin is a good illustration of the speculative nature of today’s stock market. According to LSEG data, net flows into the ten largest spot bitcoin funds reached a stunning $2.2 billion in the week ended March 1. The cryptocurrency has soared nearly 160% since October and jumped 44% in February alone. February’s action followed the Securities and Exchange Commission’s approval of 11 spot bitcoin ETFs in late January. Most crypto analysts believe these ETFs should give the current rally a boost. The underlying assumption is that institutional investors are more likely to commit long-term money to exchange-traded crypto products than they would commit to Bitcoin directly. This may prove to be an important viewpoint. ETFs represent a relatively new form of leverage, and the importance of this is that new forms of leverage have been major factors behind every financial market bubble.

Bitcoin is representative of today’s financial markets for several reasons. It has the backing of a new generation of investors and there are no underlying fundamentals. Bitcoin has no assets, earnings, or revenues to analyze, yet it is soaring based upon the belief that it will go higher. Likewise, momentum, liquidity, and leverage drive an equity bubble, not fundamentals.

Housing, Income, and Employment

Fundamentals may not be driving the current market, but it was a week full of economic data. The pending home sales index fell to 74.3 in January from 78.1 in December and remains well below the long-term average of 100. Census Bureau data showed the median price for a new single-family home fell 2.6% YOY in January; and though this may appear to be a negative, it was an improvement over the 13.9% decline reported in December. This data reveals the impact rising mortgage rates have had on the homebuilding industry.

However, the National Association of Realtors (NAR) survey indicated that the median price of an existing single-family home rose nearly 5% in January and the FHFA purchase-only house index showed an even better price gain of 6.6% YOY in December. See page 3. The stability in existing home prices may be due less to increasing demand and more to a low level of inventory, however, homebuilding stocks have been one of the best performing sectors of 2024. One reason for this was the breakout in the SPDR S&P Homebuilders ETF (XHB – $103.44) in late 2023 and the attention this technical chart received on several social media platforms. Price momentum, charts, and social media are important drivers of the new age of investing.  

Personal income increased a healthy 4.8% YOY in January and disposable income increased 4.5% YOY. However, real personal disposable income only grew 2.1% YOY, which was the slowest pace in twelve months. Personal consumption expenditures grew 4.5% YOY, which was impressive given the pace of personal income, yet it was the weakest pace in nearly three years. January’s consumption slowdown was predictable since spending had been exceeding income at the end of 2023. But in general, personal income trends appear to be slowing. See page 4.

The slowdown in consumption resulted in a modest increase in the savings rate, which inched up from 3.7% to 3.8% in January. Last month we pointed out an interesting trend in government workers’ wages. It continued in January. Government wages grew at an 8% YOY pace whereas most other sectors experienced wage growth of 4% to 6%. This disparity in wages between government and private workers is historical! See page 5.

January’s relatively low consumption pace was also due to an increase in personal taxes, which is typical of the first quarter. Also weakening household consumption is the massive jump in personal interest payments which has been a direct result of rising interest rates. An additional negative for households is the fact that government transfer payments are no longer supporting income. For all these reasons, Friday’s payroll data will be noteworthy. The household survey had a sharp decline in job growth in January and we will be looking to see if this was a one-off event or the beginning of a trend. This could be important since the household survey captures many lower-income workers that are not included in state payroll data. For this reason, it is often a leading indicator of employment trends. See page 6.

The ISM manufacturing index fell from 49.1 to 47.8 in February with six of its ten components falling, or remaining, below the 50 breakeven level. The ISM nonmanufacturing index rose from 55.8 to 57.2, with four of its nine components registering below 50. It was also notable that both surveys show employment contracting in February, with the manufacturing index at 45.9 and the nonmanufacturing index at 48.0. This could be an omen for future jobs data and therefore personal income. See page 7.

The best piece of economic news in the past week was the PCE deflator for January which eased from 2.6% YOY to 2.4% YOY. Core PCE edged down from 2.9% to 2.8%. The stock market celebrated this report since it supports the view that inflation is slowly decelerating and if so, interest rates may soon decline. With this in mind, February data for the CPI and PPI will be released next week and both could be market moving events. See page 8.

Fundamentals and Technicals

The S&P 500 trailing four-quarter operating multiple is now 23.5 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.4 times and when added to inflation of 3.1% sums to 24.5. This is well above the top of the normal range of 23.8 and it helps to explain why equities are hoping to see inflation fall to 2%. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 9.

Conversely, technical indicators improved this week. The S&P 500 and Dow Jones Industrial Average have continued to make a series of new highs while the Nasdaq Composite index finally rose above its November 2021 high of 16,057.44 on March 1st. The Russell 2000 also definitively broke above the 2000 resistance level for the first time in two years. As we have been stating in recent weeks, this move bodes well for the overall equity market. However, the Russell 2000 remains 16% below its all-time high of 2442.74 made on November 8, 2021. See page 11. But in line with the Russell index, the NYSE cumulative advance/decline line made a record high on March 1. Most technicians are stating that the market is overbought, but our 25-day up/down volume oscillator is at 1.18 and neutral this week. This indicator is based on volume, not price, and as such, it reveals the conviction behind price moves. Our oscillator has not come close to recording an overbought reading since the 22 of 25 consecutive trading days of overbought readings that ended January 5. This means volume in advancing stocks has not been impressive and the indicator is yet to confirm the string of new highs seen in the S&P 500 index and Dow Jones Industrial Average in January, February, or March 1st. To confirm the current advance, this indicator needs to reach and remain in overbought territory for a minimum of five consecutive trading sessions. In sum, we remain cautious.

Gail Dudack

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Go Big … Going Small

DJIA:  38,996

Go big … going small.  Big has dominated the markets, at least in terms of the market averages.  The top 10% of the market is 75% of the market.  The last time it was this concentrated was 1929.  For the first time in almost 40 years, a third of the S&P is just 10 stocks.  Concentration isn’t necessarily a bad thing, leaders lead and to some degree markets always will be concentrated.  We see the issue being more in the breadth of the market – are the leaders the only thing going up?  The good news is they’re not.  The Equal Weight S&P (163) reached a new high for the first time in two years.  Historically this offers that Index a very high win rate over the subsequent year, according to SentimenTrader.com.  Given where the concentration lies, even more surprising the NASDAQ 100 Equal Weight (123) is also nudging new highs.  Concentration doesn’t kill markets, it’s losing participation that kills markets.  This market seems yet to have done so.

We have likened Nvidia (792) to Cisco (48) for a couple of glaring similarities.  They pretty much are the names associated with their respective innovations, the Internet and AI.  Innovation typically has been the backdrop for most bubbles. Nvidia may well be tracking Cisco pricewise, but consider that when both started their runs in October, 1998 and 2023 respectively, Cisco didn’t peak until March 2000.  Even then the real decline took many weeks to get going.  Remember too, unlike the market in 2000, “the market” this time is not itself a bubble.  To dance on the dark side we call funnymentals, back then the dot-coms didn’t have revenues let alone earnings, a bit different from what we saw from Nvidia last week.  And back then it was the “new economy,” the dot-coms, and the “old economy,” which was pretty much everything else and was moving lower.  The A/D Index background was quite poor.

After a couple of weeks of consolidation Bitcoin, particularly as measured by the ETFs new and old, is having a good week.  We can see some real bubble-like potential here, particularly on the back of the ETFs.  We have suggested some part of the rally in AI stocks likely is due to the ETFs.  When you buy an ETF, you’re buying into something like AI regardless of valuations and stretched charts.  Bitcoin shares had a good fourth quarter, in anticipation of the adoption of the new ETFs.  When this became a reality, it was a sell on the news event, particularly for the miners which dropped as much as 50%.  The recent strength could be about the so-called halving slated for April 20, which last time saw a subsequent quadruple for Bitcoin.  While this could be anticipatory buying resulting in another need to sell on the news, sufficient unto the day.

When we think of Biotech we think of those who discover the stuff, the drug companies those who sell the stuff.  Clearly the latter do both, but when you hear about “trial” most often it’s in reference to Biotech.  On Tuesday Janux Therapeutics (48) announced encouraging results in its trials for solid tumors, while Viking Therapeutics (77) announced positive results in a trial for obesity.  Janux Therapeutics more than tripled on the news to 50, while Viking only more than doubled to 85.  Most of us have learned, often the hard way, these trials are like standing at the roulette table and placing it all on red or black.  Still, positive outcomes can be extremely rewarding, as per the above.  Our suggestion is get a medical degree, a PhD in Biotech, and find a drop-dead smart guy who knows Biotech stocks.  Or consider the SPDR Biotech ETF (XBI-99).  It’s an Equal Weight ETF, meaning smaller companies like those above have a greater impact.

Too much of a good thing can be a problem, despite the counsel of Mae West.  The history of these glorious starts to a year is the likelihood of a stall around this time.  While the market has seemed a bit more rotational of late, the numbers about which we care the most, the A/Ds, show almost surprising strength – in keeping up with those unweighted averages.  While it may be time for a stall, we’ve chosen that word carefully.  When the average stock is acting as well as it is now, there would not seem great risk.  Valuations to our thinking, no surprise, are pretty much useless.  Most argue by P/E standards stocks are not expensive.  Yet valuations relative to the rest of the world are comparable to 2000, stocks relative to bonds are the most expensive in two decades.  Best to just pay attention to the market – most days most stocks go up.

Frank D. Gretz

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US Strategy Weekly: Not Normal Times

A Government Shut Down Looms

In normal times, investors would be worried about the possibility of a government shutdown by the end of this week, but these are not normal times. Two months ago, Congress agreed to $1.59 trillion in discretionary spending for the fiscal year that began on October 1. Nonetheless, in-fighting by House Republicans is making it difficult for House Speaker Mike Johnson to pass funding bills. As a result, the first batch of government funding, for agencies that oversee agriculture and transportation, will run out this Friday at midnight. Funding for other agencies including the Pentagon and the State Department will expire on March 8. The main issues appear to be that Republicans want to see spending cuts and policy positions that address migration along the Mexican border. President Joe Biden is arguing for funding for Ukraine. It seems reasonable that both sides could find a mutual solution to these issues; but then again, nothing is reasonable or logical in Washington DC, particularly during an election year.

In addition, the market is also shrugging off a report from Moody’s Analytics stating that the banking sector faces $441 billion of CRE loans maturing this year and Moody’s forecasts the share of troubled loans will increase. The Department of Justice has launched an antitrust investigation into UnitedHealth Group (UNH – $513.42). Russia has ordered a six-month ban on gasoline exports as of March 1 and the Organization of the Petroleum Exporting Countries, led by Russia, agreed to extend voluntary cuts totaling about 2.2 million barrels per day into the first half of this year.

Bubbles are Not Bull Markets

These are not normal times for equity investors for a number of reasons. The most important of these is the possibility that equities are in the early stage of a stock market bubble. Last week’s response to Nvidia Corp.’s (NVDA – $787.01) fourth-quarter earnings report increased the odds that equities are indeed forming a bubble. We were asked if this means we are now bullish, which is not an easy question to answer. Although we expect stock market indices will move higher, perhaps substantially higher, this is different from being truly bullish, in our view. To us, being bullish means stocks represent good value and have excellent long-term potential. A bubble is quite the opposite. It means stocks have disconnected from fundamentals and are driven purely by sentiment, liquidity, momentum, and leverage. To us, this kind of stock market is like a boat at sea without a rudder.

In terms of fundamentals, the trailing four-quarter operating SPX PE multiple is now 24 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.7 times and when added to inflation of 3.1% sums to 24.8, well above the top of the normal range of 23.8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. See page 8.

Bubbles are usually fueled by a theme that supports the concept that “it is different this time” and therefore fundamentals no longer matter. The current bubble’s theme is generative AI. In our opinion, AI is less transformative than the Nifty Fifty stocks were in the early 1970s era that preceded the January 1973 peak. Beginning in the late 1960s, Baby Boomers began to enter the workforce and were the source of a massive wave of consumption of new products like cameras from Polaroid Corp. (delisted), film from Eastman Kodak Co. (KODK – $3.53), drinks from Coca Cola Co. (KO – $60.34) and burgers from McDonald’s (MCD – $293.76). These consumer stocks did represent the growth segment of the stock market, but they eventually rose to unsustainable prices.

Some strategists have said the current market is nothing like the dot-com bubble that led to the January 2000 peak, because today’s AI stocks have earnings and the dot-com stocks of the late 1990 era did not. It is true that companies like Global Crossing inflated their reported earnings figures and ended up being acquired by Level 3 Communications, and then CenturyLink Communications, LLC in 2017, and is now part of Lumen Technologies (LUMN – $1.54). But the dot-com bubble also included Amazon.com (AMZN – $173.54), Microsoft Corp. (MSFT – $407.48), eBay Inc. (EBAY – $44.39), and Cisco Systems (CSCO – $48.31). These stocks clearly had earnings. In fact, the current environment is very similar to the dot-com era and perhaps one could say this might be the second act of the dot-com bubble!

We have written about the three strategies one can employ during a bubble: 1.) jump on the bandwagon and follow the momentum stocks. For many money managers who are measured against the S&P 500’s performance, this is the only possibility. However, one has to remain diligent about monitoring the market for weaknesses that may suggest the bubble is about to burst. 2.) own a blended portfolio of stocks with good long-term potential and add ETFs that mirror the indices. 3.) own a portfolio based on good fundamentals and simply wait out the bubble. One’s strategy is an individual choice.

Election Year Seasonality

This is an election year and stock performance in an election year ranks third in the four-year election cycle. In short, it is in the middle of the pack. In an election year, the fourth quarter usually provides the best performance in the Dow Jones Industrial Average. The second and fourth quarters are the strongest in the S&P 500 index, and the second quarter has the best record in the Nasdaq Composite index. In general, the best performance tends to come in the last three months of the year. See page 5.

But what we find most interesting about election year performances is that monthly performance is different based upon whether an incumbent president wins or loses. Normal seasonality suggests that April, November, and December are the best-performing months of the year. But analyzing election years since 1944, we find that incumbent wins are preceded by strength in June, March, and December, in that order of magnitude. Incumbent losses are preceded by the best equity performance materializing in November, April, and May, which is closer to normal seasonality. (Note that the weakness seen in March 2020 correctly indicated a Trump loss.) See pages 5 and 6. However, the rally seen in February to date is not typical of a normal or an election year. So far 2024 is far from typical!

Confidence After what seemed like an improvement in confidence in January, The Conference Board confidence indices took a negative turn in February. Moreover, the January indices were revised substantially lower. The Conference Board expectations index dipped back below 80, the threshold typically associated with recession. Across age demographics, consumers younger than 35 and older than 54 saw the greatest deterioration in confidence and many respondents indicated jobs were harder to find. This was an interesting shift from earlier. The University of Michigan sentiment data will be released Friday. See page 7. The most important economic release of the week will be the PCE price deflator on February 29. The December data showed the PCE deflator unchanged at 2.6% YOY and core down 0.3% to 2.9% YOY. The market is hoping (expecting?) that inflation will continue to moderate.

Gail Dudack

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US Strategy Weekly: Nvidia in the Spotlight

The equity market is in the early innings of a stock market bubble, in our view. For bubbles to form there is normally a new generation of investors, excess liquidity, and an underlying development, discovery, or invention, which makes the economic backdrop “different this time.” The concept of being “different this time” is important since it is at the crux of how the equity market can disconnect from underlying fundamentals.

In the current environment the most obvious new “invention” is generative artificial intelligence, or AI. Today’s economic backdrop is seen as accommodative for equities based upon the consensus opinion that inflation is trending toward a benign 2% level, a pivot in monetary policy from tightening to easing is ahead, and there is no significant recession on the horizon. Any challenges in any of these areas could derail the bubble. However, of these three criteria Federal Reserve policy is the least important. It is likely that investors can, and will, adjust to the fact that a Fed rate cut may not materialize any time soon.

Eyes on Nvidia

What would be a shock to the market would be if generative AI does not become the earnings driver that analysts expect it to be. This helps to explain why earnings results for chipmaker Nvidia Corp. (NVDA – $694.52), which controls 80% of the high-end chip market, will be a critical barometer for the market and for the bubble. Nvidia earnings are released on Wednesday which makes this the most important day of the week. The 40% gain in Nvidia’s stock price this year has driven NVDA’s market capitalization past that of Amazon.com, Inc. (AMZN – $167.08) and Alphabet Inc. (GOOG – $142.20), placing the stock in third place behind Microsoft Corp. (MSFT – $402.79) and Apple Inc. (AAPL – $181.56) in terms of size. The company has also replaced Tesla, Inc. (TSLA – $193.76) as Wall Street’s most traded stock by value after $30 billion worth of its shares changed hands, on average, over the last 30 sessions. This turnover was greater than Tesla’s average of $22 billion per day in the same period. With a forward PE ratio of 32 times, many analysts expect a blow-out earnings quarter for NVDA.

While in the World

The focus on Nvidia’s earnings release has overshadowed a number of other events this week including the $80 billion merger of Capital One Financial (COF – $137.39) and rival Discover Financial Services (DFS – $124.42), Walmart Inc. (WMT – $175.86) buying smart-TV maker Vizio Holding Corp. (VAIO – $11.08) for $2.3 billion, Russia taking over the Ukrainian town of Avdiivka in a chaotic bloody battle, the United States being the only veto to a United Nations Security Council resolution demanding an immediate humanitarian ceasefire in the Israel-Hamas war, and the US announcing a major package of sanctions against Russia in response to the death of opposition leader Alexei Navalny while he was in prison.

Economic Results

The National Association of Home Builders confidence index rose 4 points in February to 48, driven entirely by expectations which rose 1.3 points to 78.4. These results are up nicely from recent lows but remain well below pre-Covid-19 levels. The Census Bureau released data showing total housing starts fell 14.8% YOY in January, while single-family starts rose 22% YOY. Similarly, new housing permits rose 8.6% YOY and single-family permits rose a much stronger 35.7% YOY. This data seems to suggest that the boom in multi-family construction may be slowing. See page 3.

In January and on a seasonally adjusted basis, total retail and food services sales increased a modest 0.6% YOY. Excluding motor vehicles & parts, retail sales rose a slightly better 1.2%, and excluding motor vehicles & parts and gas stations, sales rose 2.2% YOY. However, based on 1984-84 dollars, retail sales fell 2.4% YOY, making January the 11th time in 15 months that real retail sales were negative on a year-over-year basis. This has been one of the longest stretches of negative real retail sales not accompanied by an economic recession. See page 4.

In the post-COVID-19 era there have been only two components of retail sales that consistently gained market share, and these are nonstore retailers and food services & drinking places. In other words, in a period of negative real retail sales coupled with gains in nonstore retailers and food services & drinking places, many other areas of the retail sector have been suffering greatly. Auto sales are a large component of total retail sales; and while autos had a healthy rebound from their COVID lows, it was not sustained, due in large part to increases in interest rates, gas prices, and auto insurance costs. See page 5.

The University of Michigan sentiment index for February was 79.6. This was little changed from January’s 79.0 reading, but it was up nicely from November’s 61.3 survey. Expectations led the gain, rising from 77.1 to 78.4. Current conditions fell from 81.9 to 81.5. The University of Michigan often includes political affiliation in its sentiment surveys, and this can be interesting to monitor. What is seen on page 6, is that one’s confidence tends to rise or fall depending upon which party you favor, and which party is in power. Democrats have displayed higher levels of consumer confidence during President Biden’s term in office, although even Democrats have shown less confidence in recent years than during President Trump’s term. Nonetheless, in February, sentiment improved substantially for Republicans and Independents, but fell for Democrats. See page 6. It will take time to see if this sentiment shift has any meaning for the November election.

Valuation

After slight declines in both the S&P 500 index and consensus earnings estimates, the trailing operating PE for the SPX is 23.3 X this week and remains above all short and long-term PE averages. The sum of the S&P’s 12-month forward PE of 21.2 and January’s CPI of 3.1% YOY equals 24.3, which is above the fair value range for equities, i.e., more than 23.8. In short, the market is richly valued. We are focused on this year’s earnings forecasts, but it is curious to note that the LSEG IBES consensus earnings estimate for last year was lowered by $2.71 to $221.84 this week. The S&P Dow Jones 2023 earnings estimate is unchanged at $211.10. See page 8.

Technicals

The S&P 500 and Dow Jones Industrial Average continue to make new highs while the Nasdaq Composite index inches closer to its November 2021 high of 16,057.44. Meanwhile, the Russell 2000 remains the most interesting index as it struggles to better, and stay above, the key 2000 resistance level and move out of the 1650 to 2000 range that has contained prices for two years. If the Russell can stay above this range successfully, it would be bullish for the overall equity market. Conversely, if the Russell fails to stay above the 2000 level and/or if the Nasdaq fails to move into new high ground, it could be a negative for the broader market. See page 9. The 25-day up/down volume oscillator is at 0.43 this week and neutral. However, it is rising from the lower end of the neutral range. This indicator should reach and remain overbought for a minimum of five trading sessions to confirm new highs in the marketplace. The last string of overbought readings ended on January 5.

Gail Dudack

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Every Trend Must Go Too Far

DJIA: 38,773

Every trend must go too far … and evoke its own reversal. Surprising how little has changed since Heraclitus made that observation back in 500 BC. The question, of course, is how far is too far? Typically, it’s further than you think. Most cries of some dire consequence come far too early, to the point they’re ignored when they finally come to fruition. And then there’s human nature. Who wants bad news when making money is fun? Realistically, did anyone really believe by putting dot-com behind a name made a company more valuable? Now it’s having some vague AI reference that does the trick. Keynes defined a speculative phase being when investors are buying merely because they believe they can soon sell for more – nothing to do with judgment or fundamentals. Think of the dot-coms, the meme stocks, and EFTs. The AI stocks are getting there, but unlikely there just yet.

If AI is in or is on its way to bubble status, unlike other bubbles there is this time an enabler called passive ETFs. ETFS have their virtues, allowing a sort of instant exposure to the market as a whole, or sectors of the market. The problem with ETFs is when like now, they seem to exaggerate an extreme. There are, for example, many ETFs which mimic an AI portfolio, passive in the sense hell or highwater, that’s what they buy. To buy one of these, like the Round Hill Magnificent Seven ETF (MAGS-37), that ETF is not going to go out and buy Procter & Gamble (157). They are going to buy more of what they already own, their mandate the Mag 7, regardless of valuation or stretched prices. The Nifty 50 became a bubble before ETFs, the dot-coms with a little help from ETFs. We suspect the AI stocks are enjoying plenty of help. We would not be surprised to see the Bitcoin stocks get a little help from their ETFs.

We have likened NVDA (727) now to Cisco (49) back in the fall of 1998. NVDA owns the AI world with its GPUs as Cisco owned the Internet world with its routers. They were and are, respectively, the way to play those innovations, the breeding ground by the way for most bubbles. NVDA and SMCI (1004) pretty much are tracking CSCO during its bubble phase, which if it sounds worrisome it is not. From the start of its bubble phase in late 1998, Cisco didn’t peak until March 2000. Then, too, maybe the ETFs will hasten things along. Psychologically speaking, for stocks like these the time to sell is it likely when you make up your mind you never will. As a check, every now and then look at that Cisco chart in 2000.

Tuesdays 10-to-1 A/Ds is the sort of number you might expect at market lows rather than a market making highs. With rates up a bit, blame the usual suspects – Financials. As we seem to never tire of saying, it’s not the bad down days but rather the bad up days that cause problems. Wednesday’s comeback was more than respectable, certainly not a bad up day, though the A/Ds still lag the Averages. Overall the backdrop has its problems, the most glaring of which shows up on the NASDAQ. Against almost daily highs in the Averages there, only 50% of those stocks are above their 200-day, that is, in uptrends. And last week there were just about as many 12-month new lows as 12-month highs there. A momentum driven market like this can override these divergences for a time. In 1987 the market ignored ongoing divergences from March to October, and then of course it didn’t. For sure this is not a time you want to see those bad up days.

Often confused are stocks and their companies. Stocks are not their companies. Stocks are pieces of paper, subject to many crosscurrents, the Fed being one, but only one. Companies may remain stable, yet their stocks subject to excesses both up and down. Back in March 2000 Cisco the company was doing fine, the Internet and Cisco’s routers were transforming the world. Cisco the stock fell 89%. It has been almost 25 years, best we can tell the Internet is still alive and well and so too Cisco the company. Yet Cisco the stock is still not back to its 2000 high. This is by way of perspective, not a call to sell AI. Indeed, bubbles are a wonderfully profitable time – while they last. An old Wall Street story is one of a wonderful party, enjoyed by all. Everyone knew there was a time the party would end – but the clock had no hands.

Frank D. Gretz

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US Strategy Weekly: Where is Goldilocks?

Last week in our strategy weekly “A Bubble, or Not a Bubble” (February 7, 2024) we outlined the three possible strategies to employ during a stock market bubble. They are 1.) participate in the bubble and buy stocks displaying the best upside momentum, 2.) add ETFs to your portfolio that mirror the market leadership in order to boost short-term performance, or 3.) continue to invest in good value stocks and weather underperformance in the near term, understanding that value will outperform in the long run and in the event that the bubble bursts. All equity bubbles eventually burst. In line with these strategies, we shifted our sector weightings last week to favor the current momentum seen in communication services, technology, and healthcare.

This week, January’s CPI report is posing the first real threat to the Goldilocks/bubble scenario. January’s inflation data showed headline CPI rising 3.1% YOY, down from December’s 3.4%, but still above the June 2023 level of 3%. This small dip in headline inflation was particularly disappointing because energy costs fell 4.6% on a year-over-year basis. The report was not only a setback to the consensus, but it also challenged the concept that the Fed will make five or more rate cuts this year. Adding to the pain was the fact that the core CPI was unchanged from December’s 3.9% YOY pace. This was distressing for the consensus which was looking for lower CPI numbers to support the view that inflation would fall to, or close to, the 2% level later in the year.

Lower inflation is an important piece of the Goldilocks scenario for several reasons. Not only does it imply a Fed pivot by mid-year, but lower inflation is vital in terms of supporting the high PE multiples seen in the current market. Moreover, stock market rallies and stock market bubbles are driven by liquidity and liquidity does not increase in an environment of rising inflation and rising interest rates. In short, inflation is pivotal to the consensus view.

However, we strenuously disagree with those who believe that owners’ equivalent rent (OER) is the main reason inflation is so high and that without OER the CPI would be growing at a pace closer to 2% YOY. As seen on page 3, owners’ equivalent rent has a 26.8% weighting in the CPI, and it rose 6.2% YOY in January. On the surface, one might conclude that OER is the main reason headline CPI remains so high. But we disagree. The weighting of OER seems appropriate since rent is often 25% to 30% of a person’s monthly income. Moreover, while rents are coming down, so is the trend in OER which was rising 8.8% YOY in March 2023. The 6.2% YOY pace reported in January was substantially down from its peak.

In addition, the calculation for OER is based on a 12-month moving average of rents. This seems fitting since rental agreements are usually renewed on an annual basis and not everyone is getting the advantage of lower rents at present. As a result, the trend in rent expense will move slowly through the CPI and the economy on the way up and on the way down. It has always been this way and only now that inflation and the Fed are major economic issues has this become a major discussion point for the bulls.

And lastly, the OER is not the only issue driving headline inflation. January’s inflation report showed big price increases in tenants’ & household insurance, water & sewer & trash collection, motor vehicle insurance, personal care, and hospital & related services. See page 4. These categories of the CPI represent necessities for most households and the price rises in this list represent a burden on home finances. This explains why the average consumer is not feeling optimistic about the strength in recent GDP and employment data. For those who do not understand why average Americans are not happy with the current economy, we say, “just look at the data” and not just the headlines.

Entrepreneurs are also feeling the pressure. The small business optimism index dropped 2 points in January to 89.9. The significance of this is that it was the 25th consecutive month below the 50-year average of 98, which is typically a sign of a recession. Six of the 10 components decreased in the month; the biggest decline was seen in sales expectations, which fell 12 points to negative 16. Actual earnings changes fell 5 points to negative 30 and hiring plans fell 2 points to 14. See page 5.

It has been an interesting week, and, in our readings, we found these interesting nuggets of information:

The top 10 holdings in the S&P 500 now make up over 32% of the index, the highest concentration seen in data going back to 1980. (https://twitter.com/charliebilello/status/1756721141547196867).

As of February 9th, the S&P 500 rose for the 14th out of the last 15 consecutive weeks. According to Dow Jones Market Data, the last time this index recorded a comparable stretch of weekly gains was March 10, 1972 (a major market top). This 2024 stretch marked the 13th time it has happened since the index’s inception in 1957.

The current market capitalization of NVIDIA Corp. (NVDS – $721.28) of $1.78 trillion is greater than the GDP of South Korea ($1.71 Trillion – IMF 2023). South Korea is the 13th largest economy in the world.

In an interview on CNBC earlier this week, Jason Trennert of Strategas, noted that the earnings for the Mag 7 stocks rose 59% YOY in the fourth quarter. The remaining 493 companies in the S&P 500 had an earnings loss of 3%.

Since inflation is in the headlines this week, we would point out that the WTI future (CLC1 – $77.68) might be about to break out above a tight cluster of moving averages. The 50-day moving average is $73.42, the 100-day is at $77.97 and the 200-day moving average is at $77.41. A break above these three moving averages would be bullish and imply higher energy prices, which would not be good for future inflation reports. The next important inflation release will be the PCE deflator scheduled for February 29.

Prior to this week’s pullback, the S&P 500 and the Dow Jones Industrial Average made a series of new record highs. The Nasdaq Composite came close to breaking its November 2021 high of 16,057.44. Still, the Russell 2000 remains the most interesting index as it struggles to better the key 2000 resistance and decisively move out of the 1650 to 2000 range that has contained prices for two years. If the Russell can break above this range successfully, it would be bullish for the overall equity market.  See page 8. The 25-day up/down volume oscillator is at minus 1.14 and neutral this week after a 524.63-point decline in the DJIA on February 13. This indicator has not come close to recording an overbought reading despite the string of record highs in the two main indices in January and February. The last favorable overbought readings of 3.0 or higher took place during 22 of 25 consecutive trading days ending January 5. To confirm the recent string of new highs in the S&P 500 index and Dow Jones Industrial Average, this indicator needs to reach and remain in overbought territory for a minimum of five consecutive trading sessions. This seems unlikely. In short, remain cautious.

Gail Dudack

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Bubble, Bubble … No Toil or Trouble, Yet

DJIA:  38,726

Bubble, bubble … no toil or trouble, yet.  The idea of a bubble of course carries a negative connotation.  That’s about the bursting of a bubble, but obviously there’s plenty of money to be made before then.  They say you don’t recognize a bubble when you’re in one, but this AI bubble seems pretty clear.  Like this one, bubbles most often are associated with some innovation, in this case it’s AI, not that long ago it was the internet and the dot-coms.  But bubbles were also associated with what might now be considered mundane like autos, railroads, and even canals.  Even the meme bubble was associated with an innovation of sorts, day trading.  Bubbles are not new, and great while they last.

Timing bubbles, of course, is more than a little tricky.  Our guess, with a little recollection, is there will be a sizable correction someplace along the line, followed by a sizable recovery.  The latter is to teach you to buy the next selloff, the one you should be shorting rather than buying.  The good news is any end to this should be some time off, if history is a guide.  The rally, the melt up from 1998 to March 2000, began coincidentally on a surprise pivot by the Fed in October.  If you take Nvidia (696) as the poster child now, it is pretty much tracking the internet poster child back then, Cisco Systems (50).  If you recall, routers were the GPUs of their day.  History doesn’t repeat, and doesn’t rhyme, but it does offer some perspective.  Cisco didn’t peak until March 2000.

As the year began, hope sprang eternal that the fourth quarter’s secondary stock performance would continue. Hope there still springs eternal, but a distinction need be made on how to measure that performance.  The Russell 2000 may be considered the go to Index here, but its 20% weighting in Regional Banks has put it at a disadvantage.  Meanwhile the Equal Weight S&P (RSP-159) has found itself in a trading range since mid-December.  Somewhat ironically, the largest equity position in the Russell is Super Micro Computer (698), up some 300 points in the last three weeks.  Like virtually all Russell positions, however, the weighting is such it has failed to move the Index.

Sell on the news isn’t exactly a new idea when it comes to markets, but rarely have we seen it happen so dramatically as it has with Bitcoin.  To be fair the real weakness seems in what they call the Miners, where a representative ETF might be WGMI (15).  From its peak around 22 at the end of December it touched 11 just a few weeks ago, and since has recovered slightly.  Faring better have been pre-existing ETFs like Grayscale (41), which from its peak a few weeks ago around 44, fell to a low round 34 and now is back above its moving averages.  Bitcoin isn’t going away and as last quarter’s anticipatory binge settles in, it seems likely to have another good run.  After all, something like GBTC remains a correction in the uptrend which began in late 2022.

Last Friday saw what we call a bad up day – up in the Averages with negative A/Ds.  We paid the price for that, so to speak, with a 4-to-1 down day on Monday, but no follow through.  You wouldn’t know it to look at the Averages, but the market has lost some of its loving feeling, a.k.a., momentum.  As the Averages have moved higher, the A/D Index – the summation of the daily numbers – peaked back on December 27.  And the market has become more divided, with both a large number of 12-month new highs and 12-month new lows. Also, stocks above their various moving averages – 10, 50 and 200 day – have been rolling over since December.  It seems time for a little more caution.  Meanwhile, the S&P Healthcare sector recently saw 18% of components at 12-month highs, a number with significant implications.  The stocks moved higher over the next six months virtually every time.  Indeed, all of the momentum measures since the October low suggest the same for the market as a whole.

Frank D. Gretz

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US Strategy Weekly: A Bubble, or Not a Bubble? That is the Question

We recently wrote that we thought the equity market was richly valued and equities would either see a pullback to lower levels or the equity market could be on the verge of a bubble. Recent market activity leads us to believe that a bubble is indeed in the making. And the mania appears to be evolving and spreading.

This week, according to the Wall Street Journal, Eli Lilly and Company (LLY – $705.03) is a possible replacement for Tesla, Inc. (TSLA – $185.10) in the Magnificent Seven stocks. Some analysts believe there might be parallels between obesity drugs and the early days of electric vehicles and this made Lilly a beneficiary of the ‘mass-culture hype” that is dominating the equity environment. This hype has driven a few stocks to valuations that are well beyond that of their peers. For example, Tesla trades at 57 times forward earnings, according to FactSet, and Lilly trades at 55 times forward earnings. For comparison, in the auto industry Ford Motor Company (F – $12.07) trades at a 6.6 multiple and in the drug industry Johnson & Johnson (JNJ – $158.06) carries a PE multiple of 15 times. In an environment where earnings growth is slowing, investors seem to be flocking to a small group of companies believed to have little competition and massive growth potential. These stocks, including the Magnificent Seven, were huge outperformers for most of 2023, and it appears they may outperform again in 2024, but with some additions and deletions along the way.

Assuming this is true, we are making a number of sector weighting shifts this week.

Sector Shifts

If the stock market is in the midst of a bubble, the strategy for most portfolio managers will have to change. Unfortunately, to keep up with the popular indices money managers will be forced to shift their focus from value to momentum. This shift is risky and not permanent; however, it is necessary if one’s equity performance is measured against benchmarks like the S&P 500. The stocks that are likely to outperform in the months ahead will be those driven by the theme of the bubble, and in the current environment this would be artificial intelligence. Artificial intelligence can take many forms in terms of companies providing AI, using AI, or being components of AI, but right now these stocks are concentrated in the technology and communication services sectors of the S&P indices. Since we believe the equity market is displaying signs of being in a bubble, we are changing sector weightings and shifting technology from neutral to overweight and communication services from underweight to overweight.

Healthcare has been performing better in recent weeks and also benefits from and uses many aspects of artificial intelligence. Moreover, the public appears to view the growth potential of obesity drugs as a significant earnings growth driver. In sum, we are upgrading the healthcare sector from neutral to overweight. The financial sector has already been among our overweight recommendations, and it currently remains there. However, within the financial sector we would focus on large money center banks and try to avoid growing problems seen in commercial real estate, credit card delinquencies, and auto loan delinquencies.

To balance out our sector recommendations we are downgrading industrials and consumer discretionary from overweight to neutral. Staples and energy are also rated neutral. Utilities, REITS, and materials are currently our recommended underweights. See page 14.

We are not comfortable being momentum followers, and would rather use fundamentals for our sector weightings, but history shows that at the core of a bubble is a disregard for fundamental value and a belief that a new era of growth is emerging. Keep in mind that in a bubble, only a small universe of stocks will take the averages higher, and a majority of stocks (in all industries) will underperform the S&P 500. More importantly, when a bubble bursts, the top-performing stocks that drove the market higher will also fall the hardest. Once a bubble bursts value stocks will also decline, but less than the overall market, and thereby outperform.

All in all, the decision to invest in and follow a bubble is an individual choice. One strategy in a bubble could be to own a collection of ETFs that mirror the indices rather than trying to outperform the portfolio benchmark. Or, for some investors, the wisest path could be to remember the story of the tortoise and the hare and stick to a slow and steady policy of value investing. This would mean weathering some subpar short-to-intermediate term performance and focusing on the longer term.

The history of bubble markets like those seen before the 1972 and 2000 peaks indicates that such markets can persist far longer than most people expect. Equities became overvalued in 1997 and did not peak until early 2000. Notice that there were 28 years between those two peaks, and we are 24 years past the last peak. In short, this is a new generation of investors. American humorist and writer Mark Twain is credited with the aphorism: “History doesn’t repeat itself, but it often rhymes.” This seems to be an appropriate warning in the current environment.

If valuation does not apply in a bubble, there are only a few tools one can use to gauge when a bubble may be about to come to its end. Bubbles are fueled by both liquidity and leverage and monitoring these can help define the age of a bubble. In terms of liquidity, there is $6 trillion in money market funds ($2.35 trillion in retail money market funds and $3.65 trillion in institutional) suggesting there is plenty of fuel to keep prices moving higher. Leverage changes in every cycle and the current cycle may be fueled more by investors leveraging equity ownership through ETFs than by using margin debt. But only time will tell.

Technicals Look Bubbly Too

The charts of the popular indices have not changed much in the past week. The Dow Jones Industrial Average and the S&P 500 recorded new all-time highs and the Nasdaq Composite is less than 3% from its record high. The Russell 2000 index, however, is more than 20% below its record peak. Moreover, after breaking out of the 1650 to 2000 range that contained price action in this index for two years, the Russell 2000 dropped back below the 2000 resistance level. See page 10. This underperformance is in line with the NYSE cumulative advance/decline line and reflects a two-tiered market.

The 25-day up/down volume oscillator is at negative 1.15 this week and is closer to an oversold reading than an overbought reading. To confirm the recent highs in the SPX and DJIA, this indicator should reach and stay overbought for a minimum of five consecutive trading sessions. If not, it suggests that investors are selling into the recent highs. This week we also have comments on economic releases including January’s employment report, weekly and hourly earnings, the ISM indices, and consumer confidence surveys. See pages 3 through 7.

Gail Dudack

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US Strategy Weekly: Earnings, FOMC, and Jobs

The S&P 500 and the Dow Jones Industrial Average recorded a series of new highs in recent sessions, triggered by the US Treasury’s announcement that funding in the first quarter would be less than previously expected and the International Monetary Fund releasing its global forecasts and announcing that a “soft landing” is in sight. (Should we worry?) But the week is far from over since on the horizon are results from many of the Mag 7 stocks, an important FOMC meeting, and January’s job report.

The Importance of AI Earnings

This is also a peak week for earnings announcements with 86 of the S&P 500 companies expected to report. To date, fourth-quarter earnings results have been mixed. And as we go to press, the stock market is trying to digest results from Microsoft Corp. (MSFT – $408.59), Alphabet Inc. A (GOOGL – $151.46), and Advanced Micro Devices, Inc. (AMD – $172.06) which failed to impress investors.

Earnings results will be important for the equity market, particularly for companies in the technology and communication services sectors, which have been leading the advance. Note that the S&P communications services sector includes highflyers like Alphabet Inc. C (GOOG – $153.05), Alphabet Inc. A (GOOGL – $151.46), Meta Platforms, Inc. (META – $400.05), and Netflix, Inc. (NFLX – $562.85), which dominate the market capitalization of the group. It also includes AT&T Inc. (T -$17.53), Verizon Communications Inc. (VZ – $42.47), Walt Disney Company (The) (DIS – $96.94), and Omnicom Group Inc. (OMC – $91.83). Given the lofty PE multiples in the Mag 7 companies, earnings results will be more important than ever. Moreover, any disappointment in the growth prospects for AI-related stocks would be a big negative for the overall marketplace.  

The S&P Dow Jones consensus estimate for 2024 of $240.08, was lowered by $0.61 last week. The LSEG IBES estimate for 2024 was $242.61 down $0.56. Keep in mind that based upon the IBES earnings estimate for this year, equities are very richly valued with a PE of 20.3 times. This is particularly high with inflation currently at 3.3%. The sum of this PE and inflation equals 23.6 and is just below the 23.8 level that defines an extremely overvalued equity market. If one uses the S&P Dow Jones consensus estimate, the current 2024 PE is even higher at 20.5 times. See page 9.

It has been our view that the equity market is at an important junction in 2024. Either earnings surge and justify current multiples, or equity prices will stall or decline until earnings improve. Another option is for equity prices to continue to rise, particularly in AI-related stocks, and to simply disconnect from fundamentals. This would be the start of a bubble market similar to those seen prior to the 1972 and 2000 peaks. This helps to explain why potential in AI-related growth is a key element to stock performance this year.

FOMC on Hold

Meanwhile, the economy appears to be stronger than many expected, and this could keep the Fed on hold for at least the next few months. We do not anticipate any significant change in policy this week, but it will be interesting to see how Fed Chairman Jerome Powell handles the press conference which could be lively. It would be unwise for the Fed to lower interest rates in view of recent economic reports. Real GDP grew 3.3% in the fourth quarter, down from the unsustainable rate of 4.9% seen in the third quarter, but strong, nevertheless. The most impressive feature of this fourth quarter growth was that all components were additive, including trade which is typically a drag on GDP. The main strength was the consumer, which was 1.9% of the quarter’s 3.3% increase. It is important to note that the 3.3% rate seen in the fourth quarter, although down on a quarter-over-quarter basis, remained solidly above the long-term average GDP growth rate of 3.2%. See page 3.

In December, personal income grew 4.7% YOY, disposable income grew 6.9% YOY and real disposable income grew 4.2% YOY. This last number is down from 4.4% in November; nonetheless, it is the 12th consecutive month of positive real income growth. This string of positive real income follows 21 consecutive months of weak or negative real income growth seen from April 2021 to December 2022. This 21-month stretch of negative real income growth was the first time negative real income did not translate into an economic recession. See page 4.

The personal savings rate fell from 4.1% to 3.7% in December. Both savings rates were well below the 22-year average of 5.8% or the long-term average of 8.5% and this could mean that many households dipped into their savings for the holidays. Recent data from the St. Louis Federal Reserve helps to explain why good economic data has not had a substantial impact on consumer sentiment. Real personal median income peaked in 2019 at $40,980, fell in 2020 and has been flat ever since. In short, despite a surprisingly strong job market, and a rise in wages, inflation has taken a toll on many households and real median income has not increased. And it helps to explain why some consumers are still struggling despite a recent deceleration in inflation. See page 5.

To understand why consumer sentiment has hovered near recessionary levels, one needs to dig deeper than just the headlines. Household spending has been concentrated on necessities. For example, in the last 3 years spending on gasoline has increased nearly 90%, transportation services spending has increased 77%, and food services and accommodation spending has increased 71%. After being confined to their homes due to COVID mandates, consumers increased spending on recreational services by 78% in the last three years. Plus, we were quite surprised to find that wages in the government sector rose over 8% in 2023, which was far more than the 5% seen in most other industries. See page 6.

Interest payments are another area that has pressured many households. Personal interest payments, increased as much as 66.5% YOY in June 2023, and were still high at 37% YOY in December. Personal taxes were down in 2023 after substantial increases in 2021 and 2022. And what may prove to be the most significant data point in 2024 is the decline in government stimulus. The chart on page 7 shows that while “other” government stimulus is steadily trending lower, it is still well above normal. The surge in fiscal stimulus in 2021 helped boost consumption and the economy and may be the single reason many recessionary signals proved to be either wrong or too early.

Technical Update

A new set of breakouts materialized in the S&P 500 and the Dow Jones Industrials this week generating a series of new all-time highs. The Nasdaq Composite is running to catch up. However, the Russell 2000 remains the most interesting index. After beating key resistance at 2000, it retreated below this level early in the year, and failed at another breakout attempt this week. There is still time for a breakout, and if the Russell succeeds, it would be bullish for the overall equity market. See page 10. The 25-day up/down volume oscillator is at 0.13 and neutral this week after being in overbought territory of 3.0 or higher for 22 of the 25 consecutive trading days ending January 5. To confirm this week’s advance the indicator should reach and remain in overbought territory for a minimum of five consecutive trading sessions in coming weeks.

Gail Dudack

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