The chart below represents trading in the Financial Select Sector SPDR ETF (XLF) with a portfolio of the big-name banks and other financial institutions, a major stock sector for obvious reasons. Looking at the XLF chart over the last two years as a proxy for the financial stocks we can see that a very negative price pattern has developed. These stocks are being sold with very heavy volume and bouncing with very light volume. This is a dangerous trend because it shows that the large institutions are exiting this group. And using rallies to sell. Until the price action improves for the banking sector, I will find it hard to get bullish on the market over the longer term. Typically during times of major selloffs there will be periods when stocks become oversold, resulting in some bounce backs. While bear market bounces can be fast and furious, they also are typically short lived.
Selling climaxes occur when a stock makes a 12-month low but then closes the week with a gain. They are a sign that stocks are going from weaker to stronger, more sophisticated hands. Buying climaxes occur when a stock makes a 12-month high but closes the week with a loss. They are a sign of a stock going from stronger to weaker, less sophisticated hands. This chart from Investors Intelligence shows an extraordinary number of stocks with selling climaxes compared to last year when buying climaxes were signaling stock declines. Work by Investors Intelligence shows that sellers into buying climaxes and buyers into selling climaxes are right about 80% of the time after
The Ned Davis Research Composite Model for the U.S. Stock Market is based on an equal weighting of 50% of U.S. stock market internal and 50% external indicators. The NDR model has proven to be an important tool for identifying periods of outperformance and underperformance for the stock market. While the top chart plots the S&P 500 Index, the bottom chart plots the NDR composite score, which has moved down below 55. That represents bearish conditions and negative returns for the market. Composite readings above 70 represent bullish conditions and readings between 55 and 70 represent neutral conditions.
AS NDR explains: “By combining multiple indicators which historically have been shown to add value in broad market investment decisions, we can objectively assess the weight of the evidence and generate a summary broad market recommendation.”
It is important to note, as shown in the two boxes below the chart, that historically there have major negative market returns when the NDR Composite has been below 55. The boxes also illustrate the accuracy of the model in bullish and neutral conditions.
Here’s the composition of the internal and external indicators.
Internal Composite Indicators are tape-based (i.e., price-driven) indicators and include:
• Big Mo Multi-Cap Tape (DAVIS250A)
• Moving Average Slope (S61)
• Deviation from Trend Slope (S62)
• Deviation from Trend Reversals (S221)
• Momentum Reversals (S222)
• Net New 30-Day High Reversals (S223)
External Composite Indicators are non-price indicators and include:
In the spirit of a picture is worth a thousand words, this week we leave you with a fascinating chart showing the changes in the yield curve from 1990-2018.
It’s truly mesmerizing.
Click on the image to view the animated data visualization chart.
Recently, the yield curve has flattened out as interest rates have risen but the curve has shifted more dramatically due to changes in short-term bonds. Of course, rates increased from an artificially low starting point. While an inverted curve has correctly forecasted prior recessions, plenty of fiscal stimulus has been pumped into the economy in the form of tax cuts. Consumer confidence has also surged. But, so have debt levels. Real incomes are stagnant. The Federal Reserve is shrinking its balance sheet.
So, while the circumstances today do not resemble the past, it probably won’t be different this time. Just look at the stock market. Small cap stocks are in a bear market. Hardly anyone noticed. Rougher times are likely ahead.
The Federal Reserve’s balance sheet has begun to show the effects of the Quantitative Easing unwind. To date, approximately $375 billion has been removed from the Federal Reserve Bank assets. It should be noted that this reduction is a small fraction of the liquidity that was pumped into the financial system since the global financial crisis. The removal of Fed liquidity is one key reason the credit and equity markets have become unsettled over the past two months. The ongoing liquidation of the Fed’s balance sheet will continue to pressure equites.