Goodbye Annus Horribilis

Many are calling 2020 annus horribilis (a Latin phrase meaning “horrible year”) due in large part to the spread of the deadly COVID-19 virus around the globe and its knock-on effects on the global economy. Yet despite the various challenges 2020 posed to the world, it was a good year for investors. The gains seen in the Dow Jones Industrial Average, S&P 500, Russell 2000, and NASDAQ Composite index were 7.3%, 16.3%, 18.4% and 43.6%, respectively. And as shown by these figures, the year provided excellent gains for many stocks and spectacular gains for others. Moreover, if historical precedents and Wall Street adages hold true to form, 2021 could add to these gains. For example, the Santa Claus Rally which includes the last five trading days of the year and the first two trading days of the new year, produced a small increase which is a favorable sign for the next twelve months. In addition, the market’s performance in January has had a respectable history of predicting the outcome for the entire year. Many believe the first five trading days of January predicts the month and January’s performance predicts the year. We believe January’s action is important since the liquidity generally available to investors early in the year from tax-loss selling, annual work bonuses, IRA and pension funding is typically the best of all the twelve months; therefore, January should produce a positive result for equities. If not, it is a warning. So far, 2021 is off to an excellent start.

While 2020 was a historic period in many ways, it was also record breaking in terms how countries responded to the global pandemic. Most nations boosted their ailing economies with massive fiscal or monetary support, or both. In our view, liquidity was the primary driver of equity gains in 2020. According to the International Monetary Fund, as of September 2020, total worldwide fiscal stimulus amounted to $11.7 trillion, or 12% of global GDP. In the US, the $2.7 trillion authorized by the CARES Act was direct fiscal support to the US economy and the $3.2 trillion increase in the Federal Reserve’s balance sheet provided monetary stimulus to the banking system. Combined, these policies equaled 23% of annualized US GDP. Moreover, Congress passed an additional $900 billion pandemic relief package in late December. Before lawmakers closed the books for 2020, they tacked on a $1.4 trillion catchall spending bill. All in all, the total stimulus authorized in the last twelve months is equal to 38.8% of nominal GDP. This extraordinary stimulus not only buoyed an artificially shutdown economy, but it also helped drive equity prices to record levels.  

It was also fiscal stimulus that drove the personal saving rate to 34% in April. November’s savings rate fell to 12.9%, yet this still remains more than twice the long-term average of 6.2%. A strong personal savings rate is an auspicious sign for the economy as well as for equity performance for the first quarter of 2021. In addition, with Democrats now in control of the White House, both chambers of Congress and with ex-Fed Chair Janet Yellen, a proponent of easy monetary policy, appointed as Secretary of the Treasury, most investors expect more fiscal and monetary stimulus in 2021. The Wall Street adage “Don’t Fight the Fed” will be an important phrase to remember in 2021. For these reasons, one could expect more stock gains ahead.

Still, there is a dark side to liquidity. The main risk of excess liquidity in the system is the potential of a stock market bubble. We expect the phrase “stock market bubble” to be mentioned often in 2021, however, bubbles are not well understood by many investors. Bubbles can materialize in any form of investment. The first bubble in recorded history was the Tulip Mania during the Dutch Golden Age in 1637. Bubbles are complicated and have many components, but they are almost always underwritten by good economies and excess liquidity. They are also distinctive because they incorporate a belief that the cycle “is different this time” and prices can continue to rise even as they disconnect from fundamentals. For all these reasons, including the lofty level of PE multiples at the end of 2020, we are optimistic yet cautious about 2021. It is important to remember that bubbles can persist longer than many expect. This was proven in late 1997 when equities disconnected from normal valuation benchmarks yet continued to rise until March 2000. To analyze a bubble and its growing risks, one must monitor both the level of equity ownership and the amount of leverage in the system. Bubbles typically end only after all potential investors have joined the bandwagon, households reach an over-ownership level in equities, and leverage, or margin debt, has reached its limits.

In the third quarter, equities were 25.4% of total household assets as compared to the 2000 peak of 26.4%. Equities were also 22.6% of financial assets versus the March 2000 peak of 24.2%. Given the recent gains in stock prices, it is likely that equity percentages increased in the fourth quarter and we will continue to monitor ownership levels for extremes. But ownership is apt to move higher. New investors are joining the investment world as a result of new digital venues and websites such as,, and From an historical perspective, many of the aspects of a bubble such as excess liquidity and new investors, seem to be moving into place. And we would also note that in early January there was a jump in bullish sentiment in the Association of American Individual Investors survey. The one-week reading of 54.0% bullishness was the most extreme since November 11, 2020 of 55.8%. Too much bullishness is not a good timing device, but this does suggest investors should remain alert in 2021.

Even so, the most troublesome characteristic of an equity bubble and the key signal that a bubble is reaching its exhaustion phase is tied to the use of leverage, or margin debt. An extreme is reached when increasing levels of leverage, or margin debt, fail to lift stock prices much higher. This is a serious warning for investors. We can monitor this by comparing the 2-month rate of change in margin debt to the 2-month rate of change in the Wilshire 5000 index. If the 2-month rate of change in margin exceeds two standard deviations (15.3%) and the Wilshire price index does not follow suit, the bubble may be in trouble. The most recent negative signals from this indicator were seen in December 1999, June 2003, and May 2007. In November, the 2-month rate of change in margin debt was 10.4% (below the 15.3% standard deviation warning level) and the 2-month rate of change in the Wilshire was similar at 9.7%. In short, there were no signs of excessive margin or exhaustion in recent data.

To sum up, while it is possible that 2021 could be planting the seeds for an equity bubble it is equally possible that 2021 could become a tricky roller coaster year for stocks. There are signs of rising inflation emanating from rising oil prices, wholesale prices and a weak dollar. More inflation could lead to higher interest rates which could trigger an equity market correction. The weakness seen in the job market at the end of the year could lead to disappointing economic data, hurt investor optimism, and stall stock prices. Given this backdrop, investors should take a multiyear view of equities and seek companies that one wants to own over the next decade. This should be both the path to profits and preservation of capital. Expect 2021 to be an interesting and volatile year.

Gail Dudack, Chief Strategist

Disclosure: The information herein has been prepared by Dudack Research Group (“DRG”), a division of Wellington Shields & Co.  The material is based on data from sources considered to be reliable; however, DRG does not guarantee or warrant the accuracy or completeness of the information.   It is published for informational purposes only and should not be used as the primary basis of investment decisions.  Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security.  The opinions and estimates expressed reflect the current judgement of DRG and are subject to change without notice.  Actual results may differ from any forward-looking statements.  This letter is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity.

This communication is intended solely for use by Wellington Shields clients.  The recipient agrees not to forward or copy the information to any other person without the express written consent of DRG.

Copyright © Dudack Research Group, 2021.

Wellington Shields is a member of FINRA and SIPC

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US Strategy Weekly: Debt and Ownership

The 2020 gains in the popular indices are remarkable, yet surprisingly disparate. The Dow Jones Industrial Average is up 5.8% year-to-date. The S&P 500 has done somewhat better with a 14.4% gain. A sharp end of the year advance in small capitalization stocks drove the Russell 2000 to a year-to-date gain of 17.5%; however, it is the technology-laden Nasdaq Composite that is this year’s hard-to-beat champion with a 40.4% year-to-date gain. The Nasdaq’s performance has been extraordinary in 2020 and we would note that some bull market cycles do not experience a 40%+ gain and over the last 90 years the average gain in the S&P 500, prior to a 10% correction, has been 58%. Perhaps more significant is the fact that this 40.4% gain is nearly seven times the advance in the Dow Jones Industrial Average for the same time period. Since the March 2020 lows, the Dow Jones Industrial Average and S&P 500 have rebounded 62% and 65%, respectively. After recording fresh new highs this week, the Nasdaq Composite and the Russell 2000 have rallied 84% and 95.5%, respectively off those lows. It has been a spectacular year for investors, particularly since it also included the worst recession since the Great Depression and a bear market in earnings.

Investors have written off 2020 earnings and instead focused on the projected rebound in 2021 earnings. But even so, the stock market is not cheap. It is pretty clear that third quarter earnings estimates were better than expected but with third quarter earnings season practically complete, estimates are now stabilizing. In the week ended Friday, IBES consensus estimates rose $0.12 for 2020, $0.33 for 2021 and $0.43 for 2022. S&P Dow Jones consensus estimates were relatively unchanged and increased $0.05 for 2020 and $0.01 for 2021. Overall, the consensus estimates for 2021 are currently $169.18 for IBES and $166.20 for S&P Dow Jones. If one applies a 20 multiple to the IBES $169.18 forecast, it equates to an SPX target of 3384 for yearend 2021. The stock market is currently 8.5% above this target. While it is possible that earnings could outperform 2021 estimates, it seems the market has already factored positive earnings surprises in to current prices. More specifically, at SPX 3695, the 2021 year-end forecasted PE ratio for the S&P 500 is 22.2 X. The trailing operating PE ratio is 30.6 X which is higher than the June 1999 peak multiple of 29.3 X and the December 2001 peak multiple of 29.6 X.

Liquidity Wins
While we are worried about rich fundamentals, it is clear that the stock market is being driven by liquidity and as we have often noted it is not wise to “fight the Fed.” However, the market is priced for perfection, could be vulnerable to unexpected shocks and caution is warranted. As noted in previous weeks, some of our long-term indicators suggest that the market is apt to underperform over the next twelve-month period. However, this “underperformance” does not mean 2021 is destined to be a boring market. The new year could be an unusually volatile time including at least one big advance and a large decline. If so, investors should stay alert. It is wise to have stocks in one’s portfolio that can weather the volatility ahead and/or are good long-term holdings for good and bad times.

Assessing Debt and Ownership
Given our concerns about a liquidity driven market we are focused on factors that help define an equity bubble such as leverage, debt, and equity over-ownership. The Federal Reserve released financial data last week for the third quarter and it held few surprises.

Federal Debt Levels are Worrisome
Total outstanding US debt was a record $59 trillion in September, up from $53.9 trillion at the end of 2019. US debt represented 280% of nominal GDP in the third quarter, is up from 248% at the end of 2019 and is greater than the previous record of 273% of GDP recorded in 1933. See page 3.

Federal government debt grew at an annualized rate of 11.4% in the first quarter, 59% in the second quarter and 9.1% in the third quarter. It was a record $22.5 trillion in September and jumped from 87% of GDP in June to 106.3% in September. This compares to the record 110.3% of GDP recorded in 1944. Rising government debt is not a surprise given the fiscal stimulus provided during the shutdown; however, they are concerning when put into an historical perspective. See page 4.

Household debt is the second largest sector after the federal government, and it grew 5.6% in the third quarter due to an escalation in mortgages. The household’s total debt was nearly $16.2 trillion in September and represented 76.5% of GDP. However, this percentage is well below the 98.2% of GDP seen at the end of 2008 prior to the financial crisis in mortgages. In general, household debt has been fairly contained in 2020. The financial sector is also in good shape and its $17.3 trillion in debt represents 81.9% of GDP and is well below the 2008 peak of 123.7%. A healthy banking system is important for the overall economy and so is a financially stable household sector. Corporate debt actually declined in the third quarter after double digit growth in the first two quarters of the year. See pages 5 and 6. All in all, there were few surprises in this year’s debt accumulation, most of which has been due to fiscal spending. Our main concern for federal deficits would be sharply higher interest rates which would compound federal deficits going forward.

Stock Ownership Helps Net Worth but Needs Monitoring
The Federal Reserve also released household net worth and equity ownership data last week. After increasing a solid 12% in 2019, household net worth increased 4.4% in the first three quarters of 2020 to $123.5 trillion. In 2019, the increase in household net worth was due primarily to a 27.5% increase in equity holdings. In 2020 the increases in household net worth were a combination of a 16.6% increase in cash, due in large part to fiscal stimulus, and a 5.5% increase in tangible assets, primarily real estate. Equity holdings only increased 3.3% in the nine months ended September. This may be surprising to some, but remember, in the first nine months of the year the SPX gained 4.1% and the DJIA lost 2.7%. In short, it was a dull first three quarters. But we expect stock market gains will boost household net worth in the fourth quarter.

We are closely watching the relationship between equity and real estate ownership within the household sector. It is normal for residential real estate, or a home, to be a family’s main asset and thus represent the main pillar of net worth. But in the third quarter, the household sector showed equity holdings of $35.6 trillion, an amount that easily exceeded real estate holdings of $31.2 trillion. Since 1952, there have only been four other quarters in which equity ownership was greater than real estate ownership. These were the fourth quarter of 2019, the third quarter of 2018, the first quarter of 2000 and the fourth quarter of 1999. Each of these previous quarters were followed by sharp stock market corrections. More important, the two back-to-back quarters of high equity ownership in late 1999 and early 2000 represented the end of the 1997-2000 stock market bubble. See page 8. This is a worrisome precedent. We are also watching for extreme levels of equity ownership relative to total assets which could represent a saturation of demand. This can be measured as equities as a percentage of total assets and/or as a percentage of financial assets. In the third quarter, equities were 25.4% of total assets versus the 2000 peak of 26.4%. Equities were 22.6% of financial assets versus the March 2000 peak of 24.2%. Given the rally seen in equities in recent months, these percentages are apt to increase in the fourth quarter. In short, it is possible that equities are approaching an over-ownership situation. See page 9. In sum, the current advance has excellent momentum, but be alert to any and all pitfalls.

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Over-bought, Over-loved, Over-valued … but not Over.

DJIA: 29,999

Overbought in a trading range is one thing, overbought in an uptrend is something else. In an uptrend, more is better. The percent of stocks above their 200 day average is a good proxy for a medium term trend. It can also serve as a good proxy for a market overbought – 80% or more, and oversold – 20% or less. On the New York Stock Exchange the number now is above 90%, clearly an overbought extreme. As it happens, when above 90% market outcomes are better than when the levels are 70 – 80%. We certainly can argue in many ways sentiment is a bit extreme, and that stocks are overvalued. As for valuations, don’t get us started. Suffice it to say, stocks sell at fair value twice, once on their way to more overvalued and once on their way to more undervalued. Sentiment and valuations may matter in terms of risk when the trend changes, but they have nothing to do with the change itself. Momentum trumps the rest.

Monday saw the Dow drop 150 points, nothing these days, but still. Meanwhile, Monday saw more than 1700 stocks advance. To us, Monday was not even a down day, let alone an important one. Were the sort of opposite the case, the market up a couple hundred points with only 1700 advances – more declines then advances in an up market – that’s a problem. We all watch the market averages, but more important is how the advancing and declining issues relate to the averages. It’s never weakness that causes the problems, it’s the weak rallies that follow the weakness. We always remember early October 2018 when the Dow made a new high for three consecutive days while each of those days saw Advance/Decline numbers that were negative. Sometimes it doesn’t take much – a 20% decline followed, even into the seasonally favorable year end.

Last Friday saw what we consider a surprisingly positive Advance/Decline number of 3.4-to-1. It was surprising in that this far along in the uptrend you expect markets to start losing participation. What seems to have happened Friday was the rotation to banks and energy, where the sheer numbers have a big influence. The lift in these re-open stocks seems similar to the lift in old-economy stocks back in 2000. It’s what happens when there’s no one left to sell. It’s almost the opposite of the FANG stocks where lately there seems no one left to buy. The “January effect” is the tendency for beaten down stocks to rally in January, when the December tax loss selling is out of the way. The energy stocks particularly, have the look of a January effect here in December. We expect the stocks to continue to rally but these are stocks to rent, not own. We don’t see them as investments we see them as stocks you buy to sell. Together with the regional banks, they are also giving a nice boost to the Russell 2000.

Turnaround Tuesday turned into turnaround, again, Wednesday. A downgrade of some prominent Tech names certainly abetted the selling, and one has to wonder if the week’s IPO’s didn’t drain some funds. One also might wonder if the markup in those IPO’s didn’t make all of us wonder if things had, indeed, gone a bit over the top. Yet for the loss in the Dow of some hundred points, there were 1900 stocks up. The selling included most of Tech, even Tesla. That’s interesting as 12/21 looms, the day when it will be added to the S&P. When it comes to large additions, and Tesla (627) will be the largest, the stocks tend to rise into the addition date and underperform thereafter. It also was a tough day for Biotechs, but you have to say they deserved it – they have had a good run. We still think of these stocks as a solution to the re-open/stay-at-home rotation.

All the money that is anywhere must go somewhere, the adage goes. Forget the averages, it takes money to push most stocks up most days. When that changes, you want to change with it. Meanwhile, aside from the nasty day in Tech, Wednesday was an outside day down for the S&P – a higher high and lower close than the previous day. This is said to be a sign of buyer exhaustion. December is a good month, but can be sloppy in the middle. A date to keep in mind is January 5, the Georgia election. A democratic win will see the market sell off, even if temporarily. A hedge of sorts might be the solar or infrastructure stocks, stocks you probably want to own anyway. Regardless of the market, there’s still the issue of where you’re in as well as whether you’re in. This jockeying between stay-at-home and re-open seems likely to continue.

Frank D. Gretz

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US Strategy Weekly: Liquidity Wins

We focus on three issues this week. The first is that technical indicators have finally and whole-heartedly confirmed the current advance. The second is that even though third quarter earnings estimates are beating expectations, it has little relevance to a market that has been focused on 2021 forecasts since March. Based on 2021 earnings estimates, equities are priced for perfection and this is certainly a cause for concern. And third, recent data releases are defining a pattern of economic deceleration. This is also worrisome. This combination of deteriorating economics/fundamentals and strengthening price action can only be explained by the fact that liquidity is driving the equity market.

Several indicators that we monitor suggest the market is likely to underperform over the next twelve to eighteen months. But bear in mind that this does not mean 2021 is destined to be a boring market. It is more likely that 2021 could contain several bull and bear market cycles that result in little gain in the end. Investors should prepare for an unusual environment and adjust portfolios so that they can weather extreme volatility.

Economic data for November was generally disappointing. The unemployment rate declined in November to 6.7% from 6.9%, but this was due in large part to the decline in the civilian labor force. The addition of 245,000 new jobs was less than expectations and perhaps the biggest letdown was the decline in the employment population ratio from 57.4 to 57.3. The participation rate also fell from 61.7 to 61.5. In short, the percentage of the population that is employed and working is declining. See page 3.

Jobs are key to the economy. They are the most critical component of household income, personal consumption, corporate revenues, and earnings. Therefore, the steady shift of workers from temporary layoff to being permanently unemployed is disturbing. See page 4. In our opinion, the absence of CDC guidelines that would allow businesses to safely open coupled with the lack of urgency seen in Congress to pass fiscal stimulus that would support small businesses is unconscionable.

In our view, the best way to assess the job market is to monitor the growth rate of “employment” over a 12-month period. A decelerating rate that approaches zero will predict a pending recession and a recession begins when this growth rate turns negative. But a pivot in the growth rate often defines a recovery. From this perspective, the job market was arbitrarily shut down so there was little warning for this unusual recession. However, the employment low was made in April with a negative 13.5% growth rate and has been improving ever since. But November’s growth rate was still poor at negative 6%. Meanwhile, the pace of those unemployed 27 weeks or longer continues to rise and currently resembles the pattern seen in early 2009! See page 5. These statistics suggest household consumption is apt to decline in the first quarter. If so, earnings could also disappoint.

The ISM indices are good benchmarks for assessing the strength of both the manufacturing and service sectors of the US economy. However, both ISM indices declined in November and both surveys pointed to weakness in new orders and general business activity. See page 6. The NFIB Small Business Optimism Index fell from 104.0 in October to 101.4 in November which was worse than expectations. The most revealing part of the survey was that the net share of respondents expecting the economy to improve dropped from 27% to 8%. This was a perfect example of how the current number of COVID-19 cases and the accompanying restrictions are hurting small businesses and dampening sentiment.

Autos and housing have been the core of the 2020 rebound, yet both weakened in November. Total vehicle unit sales fell from 16.74 million to 15.97 million units in November and all segments of the industry showed a decline. For the second month in a row the pending home sales index fell. October’s index fell to 128.9, down from the August peak of 132.9. See page 7.

Under normal circumstances, third quarter earnings results for the S&P 500 would make us bullish, but these are far from normal times. As of December 4, 496 companies in the S&P 500 Index had reported third quarter 2020 earnings. And of these, 84.5% reported earnings that were above analysts’ expectations and 12.3% reported earnings below expectations. In a typical quarter, 65% of companies beat and 20% miss estimates. Even more impressively, companies have reported earnings that are 19.7% above estimates. This is dramatically better than the 26-year average surprise factor of 3.5% and the last four quarter average of 8.7%. In addition, more than 78% of reporting companies exceeded revenue expectations and beat forecasts by 3.6%. This compares to the long-term average surprise factor of 1.5%. Not surprisingly, the estimated earnings growth rate for the S&P 500 in the third quarter is now negative 6.1% and much improved from the July 1 consensus forecast of a 25% decline. If the energy sector is excluded, the third quarter growth rate improves to negative 1.9%. Earnings growth forecasts improved for all sectors in the third quarter, but the greatest improvement was in consumer discretionary which flipped from an expectation of a 50% decline in year-over-year earnings growth to positive 0.8% currently. However, despite all this good news for the quarter, IBES consensus estimates for 2021 are relatively unchanged at $168.85. A PE multiple of 20 times next year’s earnings equates to an SPX target of 3377, or 9% below recent closing prices. See page 10.

At SPX 3702, the trailing operating PE is 30.6 X and remains higher than the June 1999 (29.3 X) and December 2001 (29.6 X) peaks. The 12-month forward PE ratio for the SPX is 22.3 X. Both benchmarks are well above their standard deviation lines and the SPX is now trading more than 13% above the top of our valuation model’s year end 2021 fair value range. See page 11. High valuation suggests the market is vulnerable to unexpected shocks and this suggests caution is warranted.

But in direct contrast to this the popular indices continue to set a series of record highs and our technical indicators are finally confirming the advance. In particular, the 25-day up/down volume oscillator is currently 5.02 (preliminary), above 3.0 and has been in overbought territory for six consecutive trading days and for nine of the last eleven trading days. The oscillator reached a reading of 5.52 late last week which was the strongest reading since February 2019. It is our contention that new price highs in the indices should be accompanied by long and often extreme overbought readings which represent solid buying pressure. After a lengthy delay, this oscillator has finally confirmed the new highs. See page 13. And most other breadth indicators followed suit. The 10-day average daily new high indicator is robust at 380 per day and the NYSE cumulative advance decline line made a simultaneous record on December 8 with the indices. See page 14. The AAII bullish sentiment index rose to 49.1% and the last 4 weekly readings are the highest since January 2020. But while the AAII bull/bear 8-week spread is quickly rising it still remains in neutral territory. See page 15.

There is one simple way to explain the discrepancy between the underlying fundamental and technical factors of the market and it is liquidity. Historically, there has been a strong correlation between easy monetary policy and stock market gains. M2 growth peaked at 19.6% in July but in late November it was still growing at a 6.6% pace. Demand deposits at commercial banks jumped in late November from $2.5 billion to $2.97 billion. In sum, remember the wise Wall Street adage “Don’t fight the Fed.”

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We Zoom… we used to Xerox.

DJIA: 28,364

Different products, we know, but same concept – things change. There are few durable technologies and still fewer that don’t beget their own competition. Change, of course, takes time and it seems a bit premature to take action here. Indeed, it would be the inverse of catching that falling knife. In the case of Xerox (20), new and sometimes better copiers came along, new ways to Xerox, so to speak. In the case of video conferencing, already there are other ways to Zoom, so to speak. There’s a product out there called Teams, backed by a little company called Microsoft (215). Teams may not be reason to buy Microsoft, but it may be reason to be careful of Zoom (520). The numbers for Zoom, we are told, are over the top both in terms of growth and valuation. The latter, of course, doesn’t matter until it matters, but we do miss our Razr.

While Zoom seems the poster child for the so-called COVID or stay at home stocks, there are many. Time will tell, to coin a phrase, but most agree life has changed, the need for these companies will continue even when re-open becomes a reality. Sure we will fly again, but now we’ve learned there is an option. Even the FANGs have come to be thought of as COVID beneficiaries, if only because their businesses have not been impacted. This seems a bit of a stretch. These obviously are successful companies, but their success in the market seems a function of momentum chase. This could change and as a group they remain below their September 2 peak. A stock like Netflix (485) has gone nowhere since its little blowoff move in mid-July. It has been right to buy disappointments here, and there seems another opportunity? In a bit of irony, Google (1615) rallied on the anti-trust announcement, and it was good numbers by Snap (39) that dragged Facebook (278) higher on Wednesday. Go figure.

In recent weeks, there have been two points of note in indicatorland. Both involve the much overused term overbought, where there are as many measures as there are technical analysts, plus the media where measures are not required. By our measures an overbought extreme was reached on 9/2, and a very similar reading again on Monday 10/12. The former ushered in a near 10% correction into late September, the more recent a relatively modest consolidation. The bad news is Monday’s was a less than modest down day – 2.72 to 1 in terms of the Advance-Declines – and any weakness on Monday is itself unusual. The good news, and it is good news, the market has unwound the upside extreme, the overbought condition, without any follow-through to Monday’s weakness. The problem now is that back to a neutral position, the market seems just to be riding the stimulus roller coaster.

The S&P stood at 3307 on August 3, and as of Thursday was some 4.4% above that level. The August date marks three months before the election, and since 1928 the market’s performance during this period has an 87% accuracy rate when it comes to predicting the election’s outcome – an up market means an incumbent win, and vice versa. Doubt that’s of much help, but interesting nonetheless. Another date of some interest is September 30, when the S&P closed at 3363. The S&P lost 3.9% in September, marking its first down month since its loss of 12.6% in March. In turn, an up market in April led to a 15.6% gain through September. The trading system here is almost too simple to work, but it does. Go long the market when the market rose the previous month.

Gold remains in an overall uptrend and up some 20% from the March low. Since its August peak, however, it has been consolidating and as yet doesn’t quite look ready for prime time – a GDX move above 41 would suggest otherwise. Meanwhile, the ratio of Gold to Copper has dropped to a six month low, suggesting traders are seeking economic growth rather than the safety of Gold. Another positive economic sign could be the recent action in Parker Hannifin (225), not exactly a household name, but one which some see as another barometer of the economy. To get to that growth, of course, we need to get through the election. Two weeks ago the market saw stimulus in the color blue, but since then seems generally to have timed out. The possibility of a contested election, history suggests, is ample reason to do so. Since the surge and overbought reading of 10/12, it seems worth noting the NASDAQ 100 has seen only one up day, and modest at that. Anticipatory profit taking anyone?

Frank D. Gretz

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US Strategy Weekly: Counting Positives and Negatives

With a little more than two months left to the year, few would deny that 2020 has been an unusual year. The turning point was the historic, unpredictable, and relentless spread of the COVID-19 virus from China to most other countries around the world. It is not the virus, but its aftermath that will have major repercussions for people, companies, and economic trends for years to come. Yet in the face of this challenge, the S&P 500 and Nasdaq Composite Index reached new highs in September and the DJIA, SPX and Nasdaq Composite are currently 4.2%, 3.9% and 4.5%, respectively, from all-time highs.

Some believe the rally in equities reflects a disconnect between the stock market and reality. But as usual, investors face a mix of positive and negative factors. Today is no different, even when putting the political backdrop aside.

The current negatives are obvious. The spread of COVID-19 resulted in mandatory shutdowns of businesses around the world. In the US, some businesses learned to adapt, and this created a division between winners and losers. But the bottom line is that the shutdown put 22.2 million people out of work between February and April, and 10.7 million of those remained unemployed at the end of September. Another negative is a resurgence of the virus in Europe which is generating a new round of restrictions such as curfews and limits on gatherings. This resurgence places a European recovery in the second half of the year on hold. Together, these two events create a third negative which is an enormous pressure on corporate earnings and an increasing risk of small business bankruptcies. As a result, the S&P 500 index is close to peak valuations on a trailing earnings basis and even when based upon forecasted 2021 earnings valuation remains at nosebleed levels. Added to these problems is the fact that the government is challenging the power and influence of the biggest technology companies with concerted anti-trust action. This week the Justice Department sued Google (GOOG.O – $1555.93) for illegally using its market strength to fend off rivals with distribution agreements that gave its search engine prominent placement on phones and internet browsers. Anti-trust action may prove beneficial to consumers in the long run, but in the shorter run it could pressure the big cap technology stocks that represent a large percentage of the SPX’s market capitalization. In short, it could hurt market performance.

The artificial shutdown of most economies was quickly followed by a series of policy measures to keep economies afloat. In short, the positives must begin with the extraordinary stimulative fiscal and monetary policies put into place around the world. As we have noted in the past, the combination of fiscal and monetary ease announced by the US totaled $5.5 trillion ($2.55 trillion in three fiscal packages and a $2.99 trillion expansion in the Fed’s balance sheet). This $5.5 trillion represents 28% of nominal GDP ($19.53 trillion at the end of the second quarter), or 3.4 months of economic activity. This stimulus went directly to consumers and businesses and it provided a safety net for the broader economy. In addition, another fiscal stimulus package is on the horizon, it is simply a matter of time and politics.

Yet, the biggest positive for investors is how well the economy is doing, particularly the tremendous strength in housing and autos. As of September, the NAHB single-family housing environment survey has recorded three consecutive months of record readings. Homeownership rates are surging in all regions of the US and reached 67.9% in the third quarter. This represents the highest homeownership rate since the 69.2% seen in 2004. See page 3. Residential building permits recorded a 10-year high in September and existing home prices have been moving steadily upward all year. See page 4. September’s retail sales rose 5.2% YOY overall and 3.9% YOY excluding motor vehicles and parts. Autos have been the brightest part of retail sales rising 10.5% YOY in September. Plus, September’s retail sales data included many bright spots in the economy with the exception of clothing, electronics and food and beverage establishments. The best part of all these statistics is that it all bodes well for third quarter GDP. See page 5.

Benign inflation is another positive for the equity market since low inflation is favorable for monetary policy, PE multiples and consumers. In September, the CPI rose 1.4% YOY, PPI finished goods fell 1.2% YOY, final demand PPI rose 0.5% YOY, crude oil fell 26% YOY and the PCE deflator gained 1.4% YOY. The decline in energy prices and positive spread between CPI prices and PPI prices is a favorable one for corporate margins. See page 6.

And despite negative US headlines, there is good news regarding virus trends. On October 20th, The NEW YORK TIMES ran a story including charts that showed “new COVID cases” are trending higher in October, but due to the substantial increase in the number of tests taken and diagnosed since early September. Most importantly, US deaths per day have held steady since early September at around 700. See page 7. In general, this implies the spread of the virus and its deadliness is slowly fading. Moreover, therapies for the virus have advanced dramatically in the last six months and a vaccine is expected early in 2021. Overall, we believe all this good news outweighs the bad.

We have noticed that both consensus earnings estimates for 2020 have had unusually large increases in recent weeks. See page 10. IBES indicated that of the 66 companies that reported third quarter earnings to date, 86% beat expectations. Therefore, 2020 consensus forecasts are apt to move even higher. However, stock prices have ignored 2020 and for the last six months have been trading on 2021 earnings. Unfortunately, the 2021 outlook remains uncertain and this brings us to the biggest unknown of 2020 — the election.

With less than two weeks to go and with early voting taking place at a record pace, election results remain highly uncertain. The polls give former Vice President Biden a sizeable lead, but the race continues to narrow. Statista reports that 55% of Americans feel they are better off than they were four years ago and most Americans, particularly Democratic voters, feel this election matters more than previous years. This is an interesting, but inconclusive mix. See page 8. In terms of the election, the market’s 3-month performance is showing a gain in the SPX of 5.3% and a gain in the DJIA of 7.1% to date. In past election years gains have foretold of an incumbent victory. On the other hand, one cannot be sure that 2020 is a “typical” year. See page 9.

Last but far from least, the charts of the broad indices and technical indicators have turned increasingly bullish in the last two weeks. All the popular indices rallied from important support levels that equated to their 100-day or 200-day moving averages and in particular, the Russell 2000 index began to outperform large cap indices. The advance/decline line reached a record high on October 12 and the new high list continues to expand. Our 25-day up/down volume oscillator is yet to reach a fully overbought reading, but it did record its highest reading earlier this week since August 2020. These are all supporting the bullish case.

We continue to have a long-term bullish bias but would expect the market to be choppy and trendless prior to the election. If there is no clear winner on election night, the uncertainty is likely to create even more volatility. This implies investors should be somewhat cautious near term and focus on companies that will perform well despite the virus and despite an uncertain political backdrop.

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4Q 2020: Be Alert to October Surprises

There is a growing consensus that Democrats will win the White House, possibly increase their majority in the House and could even tilt the balance in the Senate. And economists are now indicating the Biden-Harris platform may not hurt the economy as much as originally expected. However, history has shown that consensus views, and economist’s forecasts, are more often wrong than right. In short, it may be wise to stay alert for October surprises.

In terms of the Biden-Harris platform, former Vice President Joe Biden has stated he will repeal the Trump tax cuts which means taxes will go up for all individuals and businesses. To say that taxes will not increase for anyone making less than $400,000 a year is simply self-contradictory. Moreover, targeting tax increases on incomes of $400,000 or more could hurt millions of small business owners who need positive cash flow to expand. The only effective way to raise taxes on the wealthy and not hurt the average worker would be to eliminate tax breaks focused on the wealthy such as the carried interest loophole. More importantly, to raise taxes while the economy is still struggling to gain its footing from a mandatory shutdown seems reckless.

Some say the positive impact of the proposed Biden-Harris fiscal stimulus will offset the negatives from tax hikes. However, the Biden-Harris stimulus plan is tilted toward infrastructure spending on green and sustainable energy sources. This is an admirable goal, and it should be done, but it will take a long time. Federal infrastructure spending tends to be slow and inefficient. President Obama’s $830 billion American Recovery and Reinvestment Act of 2009 was the largest stimulus-spending package in all of American history, and it promised “shovel ready” construction projects to spark job creation and lift the economy. Unfortunately, only 15% of the money was used for roads, bridges, and other infrastructure projects and it took more than three years to have much of any Impact. * In sum, we would be skeptical that the Biden-Harris stimulus plan will work as promised. The most effective way to stimulate the economy is to give money directly to consumers and businesses either through tax cuts or direct checks. And it should be done quickly. As Federal Reserve Chairman Powell indicated — more stimulus is needed since households need cash to pay rent and support their families.

The financial media appears perplexed by what they see as a disconnect between the soaring stock market and a weak economy; yet this disconnect may not be as big as perceived. As stock market averages are knocking on their all-time highs in October, there are also signs of a solid rebound. This can be found in the strong gains in disposable income, construction spending, auto sales, manufacturing, consumer, and business confidence. The household sector’s double-digit savings rate also points to more potential spending ahead. Perhaps the media is looking at shutdowns and virus trends while the stock market is looking to the future.

If there is a disconnect in the financial environment it is found in valuations. Equity prices are rising without a commensurate increase in earnings. As a result, PE multiples have jumped to record levels. If earnings do not rebound strongly from the big declines seen in the first and second quarters of 2020, the stock market will be trading well-above fair value. This is the crux of the stock market’s risk today.

Predicting Elections
October is an interesting month in many ways. A good equity performance in October during a presidential election year has been a good omen for the incumbent party. October is less than half over, but it is showing an above average gain to date. Furthermore, the equity market’s performance in the three months leading into the election has been a remarkable precursor of the election. A loss in either the S&P 500, the DJIA, or both, in the three months leading into the election has predicted a loss for the party currently in the White House. A gain has preceded a success. There have been few exceptions to this rule. In 1932, the equity market rallied strongly even though President Hoover (Republican), on the cusp of the Great Recession, lost the election to Franklin Delano Roosevelt (Democrat). The market also declined in the three months prior to the successful re-election of Dwight David Eisenhower (Republican) in 1956, following the Korean War. And the stock market did not predict the change in political power in 1968 when Republicans (Nixon) succeeded Johnson (Democrat). However, President Johnson failed to win his party’s nomination at the 1968 Democratic Convention and was replaced by Hubert Humphrey. But aside from these anomalies, a positive performance from the end of July to the end of October has indicated that the party in power would retain the White House.

Although high PE multiples imply investors should be cautious and maintain a solid focus on value in the short term, we find many reasons to be bullish long term. Not only are the trends favorable in most economic data but in the breadth of the market as well. The number of daily new highs has steadily increased in October and the advance decline line reached an all-time high. The Dow Jones Transportation Average made a series of new highs in mid-October and the Russell 2000 index has become the outperforming market benchmark. These are all signs of a broadening advance. Supportive monetary policy, solid economic releases, and the potential of new fiscal stimulus sometime in the next three months, also implies equities should do well in the longer term.
Gail M. Dudack
Market Strategist

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Disclosure: The information herein has been prepared by Dudack Research Group (“DRG”), a division of Wellington Shields & Co. The material is based on data from sources considered to be reliable; however, DRG does not guarantee or warrant the accuracy or completeness of the information. It is published for informational purposes only and should not be used as the primary basis of investment decisions. Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security. The opinions and estimates expressed reflect the current judgement of DRG and are subject to change without notice. Actual results may differ from any forward-looking statements. This letter is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity.
This communication is intended solely for use by Wellington Shields clients. The recipient agrees not to forward or copy the information to any other person without the express written consent of DRG.
Copyright © Dudack Research Group, 2020.
Wellington Shields is a member of FINRA and SIPC

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2020 Third Quarter Review – The Final Stretch

We believe the market is in an uptrend but the near-term forecast is decidedly unclear. It’s been a wild ride so far and President Trump testing positive for the coronavirus may only be the first of many October surprises. The market’s rapid decline to the bottom on March 23rd resulted in an historic rally to record highs in September. The rally seemed to ignore the unraveling of the U.S.-China relations, antitrust actions against big tech, the potential for a Fall coronavirus wave, and a potential Democratic sweep portending tax hikes for both corporations and some individuals. A future potential negative may be a contested presidential election.

Yet the market has parsed through these concerns and the outlook for the economy and investors is not all grim. From depressed levels, economic growth continues to build. The Atlanta Fed US real GDP tracking estimate for the 3rd quarter is at +35.2%. Notably, the following economic indicators are above pre-lockdown levels: small business optimism, homebuilders housing index, non-defense capital goods spending and household durable goods consumption. ISM services remains firmly in expansion territory, with the employment component growing for the first time since February.  The unemployment rate was nearly halved from April’s level of 14.8% to 7.9% in October and 500,000 people per week are coming off the unemployment rolls.

Positively, as a result of the lockdown, some companies have grown stronger at the expense of their smaller competitors. Accelerated investment in technology, a surge in e-commerce, and forced expense streamlining have allowed dominant companies to grow even more dominant. They are enjoying improved margins, operating leverage, and earnings growth as demand returns. S&P 500 earnings expectations have steadily increased since bottoming on May 15th, and positive earnings revisions now stand near all-time highs.

Several factors are supporting the market. Inflation is not broadly visible, the Fed issignaling a rate increase is not in the cards for the next two years, market breadth is expanding, and credit remains well-behaved. The fiscal and monetary stimulus enacted thus far has backstopped consumption, though more is likely necessary and post-election, it is a near certainty. With prospects of continued growth off depressed levels and no attractive alternative in the bond market, equities should continue to enjoy tailwinds regardless of how the election is finally resolved. We continue to stress buying quality equities with good balance sheets and long term growth potential.

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US Strategy Weekly: Trump Biden Tax Proposals

A new week brought new worries for the stock market. Moods were already downcast after the passing of Supreme Court icon Ruth Bader Ginsberg. Throughout her illustrious career Judge Ginsburg was a leader, a role model for working women and a staunch fighter for women’s rights. On Tuesday Prime Minister Boris Johnson told the British people to work from home if possible and ordered restaurants and bars to close early to counter a second wave of COVID-19. Johnson stopped short of imposing another full lockdown, as in March, but warned that more measures might be imposed if the virus were not contained. Newswire headlines announced US deaths from coronavirus surpassed 200,000 but failed to mention that the trend in new cases and deaths has decelerated dramatically. President Trump spoke (on video) to the 75th annual UN General Assembly and fueled fears of a geopolitical tiff by chiding China for unleashing COVID-19 on the world and stating that China needs to be held accountable for the destruction the plague has wrought by all members of the UN. The US Food and Drug Administration is expected to announce higher standards for an emergency authorization of any coronavirus vaccine, lowering the chances that a vaccine might be cleared before the November 3 election. And last but far from least, the first presidential debate scheduled for September 29th at 8:30 pm EST is merely one week away. This debate could become a pivotal factor for the stock market.

We believe last Friday’s Wall Street Journal’s article comparing Joe Biden’s and President Trump’s tax proposals may have been a contributing factor to the stock market’s recent decline. With Biden leading in the polls it is important for all investors to assess the impact a Democratic victory could have on the US economy. There are many factors to look at, but this week we will simplify it to tax policy.

President Donald J. Trump’s Tax Plan
President Trump’s tax policies are well known. He enacted tax breaks for individuals and corporations in 2017 and wants to extend these tax breaks past their current 2025 end date. Trump made it easier for corporations to bring home foreign profits and to deduct capital investment costs. Trump is currently proposing to cut the capital gain tax rate from the current 23.8% to 15% or 18.8%. And he wants to expand Opportunity Zones which offer capital gains tax breaks for investments in low income areas.

Vice President Joseph Biden’s Tax Plan
The Wall Street Journal article noted that Vice President Biden’s spending plans exceed his proposed tax revenue, but Biden explains this as stimulus for the economy. The Biden plan would raise taxes on individuals and entrepreneurs making more than $400,000 a year and would raise the corporate tax rate to 28%, impose a new minimum tax on companies and raise taxes on the foreign income of US based multinationals. His plan also includes reinstating the individual mandate to purchase health insurance, which is the proposal included in Obama care that the Supreme Court ruled was a tax on citizens. Mr. Biden proposes to raise the top individual tax rate of 37% to 39.6%, expand the 12.4% Social Security payroll tax which currently exempts wages above $137,700, but would restart the tax again on wages above $400,000. The plan also repeals a 20% deduction for income from pass-through businesses and impose new limits on itemized deductions. Most importantly, Biden would raise the capital gains tax rate from 23.8% to 39.6%, but reportedly only on households with income greater than $1 million. Nevertheless, this is likely to weaken the stock market prior to the election since many investors are apt to take profits on long-held stocks to avoid the possibility of this tax hike in 2021.

Millennials should take heed of structural changes to capital gains rules that Biden is proposing that could significantly impact their inheritances. At present, heirs only pay income taxes on gains in equity value that materializes after the original owner’s death and only when they sell the stock. Biden’s proposal would tax all unrealized gains as capital gains at the time of death. This is unsettling. Unless an heir has considerable liquidity at the time of inheritance this structural change would require an heir to sell much of the portfolio in order to pay taxes, incurring more capital gains taxes and potentially losing a significant amount of the inheritance. The very wealthy may have lawyers and accountants that can find a way around this tax, but Middle America will bear the brunt of this change.

All in all, we find the Biden proposals to be dicey for equities. Raising the capital gains tax rate has historically lowered stock prices in the short run as investors rush to avoid the tax hike and it lowers demand for equities over the longer-term since it raises the bar for speculators. All in all, a Republican sweep suggests more tax cuts while a Democratic sweep would bring increases.

Keep Some Powder Dry
Nonetheless, economic data has been strong. Housing data shows existing home sales rose to 6.0 million units in August, a 10.5% YOY increase. The median existing single-family home price rose 12% from a year earlier, while the average existing single-family home price gained 9% from a year ago. See page 3. August’s new home sales will be reported soon, but July’s data showed a 36.3% gain in units sold from a year earlier with median and average prices rising in the high single digits. See page 4. Homeownership also jumped from 65.3% in March to 67.9% in June, with the largest regional gain seen in the South where ownership rose from 67.6% to 71.1%. Black homeownership rose 3% to 47% and Hispanic ownership rose 2.5% to a record 51.4% in the second quarter of the year. See page 5. As a result, homebuilder confidence reached record heights in August. See page 6. In August, retail sales also reached a record level on a seasonally adjusted annualized basis and this tends to be a good forecaster of overall GDP. See page 7.

However, fundamental valuations remain stretched even as the Refinitiv/IBES consensus earnings estimate for the S&P 500 index continues to rise. This week’s estimate of $166.62 combined with a 20 PE multiple suggests a fair value level of SPX 3332, but as we show on pages 8-10 this still puts the equity market at the high end of fair value. It is possible that earnings estimates will continue to surprise on the upside, but the political climate is too uncertain to know. It is equally possible that higher corporate taxes would make current forecasts too high for 2021. In short, we remain cautious in the near term.

Technically, we see several important support levels that are worth monitoring. In the Dow Jones Industrial Average and in the Russell 2000 the 100-day and 200-day moving averages are converging. This makes the DJ 26,290 and the RUT 1457 levels crucial to the longer-term outlook. By holding at or near these levels the chart patterns improve. But breaks below these levels are highly likely to generate more selling. Breadth data is also showing some strain. The 10-day average of daily new lows fell to 76 this week and is below the 100 benchmark that characterizes a bull market cycle. The 25-day up/down volume oscillator is at minus 1.29 this week and at its lowest point since April 8, 2020. Corrections within a longer bull market cycle rarely reach a fully oversold reading on minus 3.0 or less; rather, corrections tend to reverse as this level nears. Overall, the risks in the market may only be political, but they are taking a toll on stock prices. We await the presidential debate next week.

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This time is different… really.

 DJIA: 27,739

It’s easy, even tempting, to compare this market to the bubble that was 1999 – 2000. Like then, the market is dominated by a few stocks, actually fewer than back then. Back then you learned that if you added to your company’s name it boosted your multiple almost regardless of your actual business. Multiples now may be rich, but at least there are multiples – back then earnings were rare. Enthusiasm/speculation is similar, with Call buying at levels that are comparable. The market averages themselves show similar divergences. Back then the NAZ dominated as it has done so now. At present there is a disparity even within the S&P. The Index itself is at a new high but the equal weight version – counting each stock the same – remains some 8% below its high and even below its June peak. This kind of disparity has happened only four other times in 30 years, all in 1999 – 2000.

Most of the above makes this time seem the same as 1999 – 2000, rather than different. That’s especially so when it comes to a dominant group of stocks. It’s the overall background that makes this time different. Back then it was “new economy” and “old economy.” The old economy stocks were not just lagging, they were going down. These days most stocks go up – the Advance Decline Index just made another new high. That wasn’t the case back then when there was a protracted divergence. If you think of Staples as old economy, as measured by the ETF XLP (64) the stocks are up some 14% since the end of June and 35% from the March low. For all the worries about the economy, as measured by the ETF XLI (76), Industrials are up some 60%. Certainly Tech dominates, but it’s not alone in going up. That makes this time very different.

This is not to say all have shared the wealth equally. It has been a far better recovery for the Mega-Caps of the Russell Top 50 then for the smaller companies of the Russell 2000. Winners and losers have had everything to do with the pandemic. Internet retailers are up big while hotels, resorts and cruise lines are down big. FANG stocks are now regarded as defensive plays – go figure. Meanwhile, The S&P may have gone nowhere for six months but contrarian plays like Gold and Treasuries have done very nicely. The 10-year real Treasury yield remains at almost exactly -1%, a level never reached before this year. Real yields have a relationship with Gold, which had more than a little hiccup last week. Lower real yields make Gold that much more attractive so the correction in yields helps explain the correction in Gold. The push above $2000 and news of the Buffett buy added to what might have proved too much of a good thing. All this seems likely to temper the uptrend for now, but above the 50 day – around 39 for GDX – there seems no real worry.

Everyday low prices is one thing, “priced in” is quite another. Walmart (130) had the look of the latter Tuesday morning, after what seemed a respectable report. Of course, it’s not what have you done for me lately, it’s what will you do for me now. There the news was a little less optimistic, though not exactly horrible. As it happens the stock had broken out just Monday after a month long consolidation. The top of that consolidation is around 132 which could prove support. The trading rule of thumb is sell half on any pullback below that. Looking at a long term chart, the investment rule of thumb is buy any pullback. Despite all the attention given Walmart and Amazon (3297), there are plenty of good charts in retail. There are the dollar guys, Dollar Tree (98) and Dollar General (197), and perhaps our favorite, Costco (340). It’s another story for Department stores like Kohl’s (19) and Nordstrom (14) where bad news continues to be discounted.

Glad that bear market is over – at least by the arbitrary definition of a 20% decline and retracement. Ironically, it wasn’t the best week, technically speaking. After eight consecutive days of positive Advance Declines, five of the last six have been down. Tuesday saw the NASDAQ rise 100 points while more than 60% of the issues traded there fell. Much the same was true on Thursday. For the Nasdaq Composite it was the fourth time in 15 days it had a decent gain while breadth was negative – either in terms of issues or volume. Thursday saw the Composite at a new high, the third time in 15 days it has done so with negative breadth. Thursday also saw negative breadth on the NYSE though the averages were all higher. This may not be 2000 but it doesn’t mean stocks can’t correct. And if by correct you mean stall, most already have done that. Most days most stocks go up has been the mantra of this uptrend. If that is changing it won’t be long before the trend does as well.

Frank D. Gretz

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