Out of Balance

It was September 10, 2001 when I slid into my trading turret around 5:00 a.m. to write that day’s strategy report. The stock market should have been rallying for the previous few weeks, but that was not happening. Accordingly, the first paragraph of the report read:

“I felt a great disturbance in the force . . . as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened.” Clearly a line uttered by Obi Wan Kenobi in the movie Star Wars, but how appropriate given our sense that for the past few weeks that something is/was out of balance in the universe. Whether it is an Argentine default, another Long Term Capital Management (LTCM) hedge fund debacle, a Japanese banking implosion, etc. is not really the point. The point is something is out of balance in the cosmos! We have opined that the current situation is reminiscent of the summer of 1998 when the stock market slid into the end of August and then dove 513 points on August 31st, setting up a decent tradable low. At the time NOBODY knew the reason for said slide, and then BANG – news of the LTCM implosion surfaced. Indeed, something is out of balance.

Obviously the next morning, September 11, 2001 (a day that will live in infamy), defined what was out of balance.

This morning I resurrect those words because that same feeling engulfed me late last week, not that I am predicting another 9-11, but something is out of balance in the universe. Indeed, last week’s “set up” was perfect for the prescribed “rip your face off” rally, and it pretty much worked until Thursday’s Tumble (-253 points). Maybe the causa proxima was the much feared $1.2 trillion “witch twitch” last Friday, or maybe it was the quarter point rate ratchet by the Fed, but whatever it was stocks stunk! The late week wilt left the S&P 500 (SPX/2005.55) off 0.34% on the week and me with egg on my face, a “facial event” that occurs from time to time. While most of the indices showed minimal losses for the week, it sure felt much worse than that. The SPX is now down 2.59% for the year and off 5.22% from its 52-week high. However, the average stock in the S&P 500 is down 18.6% from that same high water mark. Speaking to the sectors, the good folks at the invaluable Bespoke organization write:

“Below (see chart 1 on page 3) is a chart showing the sector breakdown of this reading. As you can see, Consumer Staples stocks are closest to their 52-week highs at -9.63%, followed by Financials (-13.24%), Utilities (-15.11%), Health Care (-15.37%), and Technology (-15.88%). The average Energy stock in the S&P 500, though, is 41.36% below its 52-week high!”

Like the S&P 500 the D-J Industrial Average (INDU/17128.55) is down a small 3.90% for the year. However, the D-J Transports (TRAN/7364.04) lost a large 2.19% last week and are now down an eye-popping 19.43% year to date. Last week the Trannies fell through their August 25, 2015 closing low of 7466.97, which is one half of a Dow Theory “sell signal.” For the “sell signal” to be complete would require the Industrials to close below their respective August 25, 2015 closing low of 15666.44, and that’s a long way away.

Undeterred by last Thursday/Friday’s carnage, an emboldened portfolio manager, namely First Republic Investment Management’s Jon Bull, CFA, writes:

On a volatile week, where stock prices round-tripped from their Fed rally (and sagged only slightly on the week), we went from NO bottom finders in the green zone, to 2 out of 18 saying we are at a bottom, and 4 more are so oversold that they will generate a buy signal on strength.

There are buy signals from:

  • 1 day TRIN (advancing issues/declining issues). The high 3.07 reading at yesterday’s close is likely enough to at least pause the decline within the next 4 days.
  • The huge 2.5 billion shares traded on today’s drop would ordinarily be climactic enough to put a bottom in --- but today was a triple witching day, so the high volume may be suspect.

Indicators oversold enough that they will generate a reliable trading buy on strength are:

  • % of NYSE stocks trading above their short term (ten week) moving average. That number dropped below 30%, is not 23% and will generate a Buy when it rallies back above 30%.
  • The High-Low 10 indicator is a very reliable swing indicator of investable rallies. We are way oversold at 9% today, and when it rises above 10%, we should get a nice rally.
  • The Zweig Breadth Thrust indicator has re-set itself by getting very oversold on 12/11 and 12/14. We just completed day 4 of a ten day window to see if there is enough follow-through to begin a major rally.
  • The weekly Expectations Curve, a derived measure of investor optimism and pessimism, is VERY oversold at 14 – lowest in 2.5 years. When it turns up to weeks in a row, it will generate a Buy.

More to come next week. The last time these went positive we had a rally to within 2/3 of 1% of the old high. We’ll see what this one brings (and from what level).

Obviously I hope Jon Bull is right because “If Santa fails to call the bears will roam on Broad and Wall.” On our sense that he is correct, we screened a competitor’s “All Weather Stocks” for the coming year, which have positive ratings from our fundamental analysts and register favorably on our algorithms. The names to put on your potential buy list include: Amazon (AMZN/$664.14/Strong Buy); Netflix (NFLX/$118.02/Outperform); AutoZone (AZO/$741.88/Strong Buy); Equinix (EQIX/$289.35/Strong Buy); Masco (MAS/$27.88/Outperform); Public Storage (PSA/$248.74/Outperform); NVIDIA (NVDA/$32.14/Strong Buy); Alphabet (GOOG/$739.31/Outperform); and Facebook (FB/$104.04/Outperform).

The call for this week: Two weeks ago the headline read, “Beware The ‘Massive Stop Loss’ - JPM's Head Quant Warns This Unexpected Downside Catalyst Looms Next Week.” For the first three days of last week that looked to be wrong, but it certainly was true late week. I am hoping the Thursday/Friday massive $1.2 trillion expiration was another aberration just like the 1100 Dow Downer of August 24th and the May of 2010 Flash Crash. As stated, the set up for a “rip your face off rally” was just about perfect with December 11th’s 90% Downside Day followed by last Monday/Tuesday’s back to back 80% Upside Days, meaning 80% of the total Up to Down volume came in on the upside. That’s typically the way bottoms are made. Normally one would expect to see some downside follow-through this morning, but preopening S&P futures are up 18 points at 6:00 a.m. So hopefully last Thursday/Friday’s “Massive Stop Loss” was indeed an aberration.

© Raymond James

© Raymond James

Read more commentaries by Raymond James