MorningWord 2/19/17: Seeing the Forest For the Trees

by Dan February 19, 2016 9:44 am • Commentary

Last night on CNBC’s Fast Money we debated two important issues related to the bounce in U.S. equities in the last week.

First, after more than a 6% rally in the S&P since last Thursday’s intra-day lows, the S&P’s first lower close in 4 sessions (down only 0.5%) was matched with gold rallying 2.4%, utility stocks, measured by the etf XLU up 1.6% and U.S. Treasury Bonds, measured by the 20 year treasury etf the TLT up 1.23%.  On the show I said that the sharp bounce in “risk off” trades was a more important indicator than large cap stocks having a fractional decline.

But there were some signs in large cap stocks if you were looking closely enough. The Nasdaq 100 (QQQ) had a fairly bad day yesterday, down 1.14% with AAPL down nearly 2%, AMZN down 1.7%, FB down 1.6% and GOOGL down 2%.  That’s some bad action by some of the largest stocks in the market (where there remains a good bit of investor optimism).

A couple of my co-panelists disagreed with my view and said that we are in a market of stocks and that there are plenty of stocks and sectors working in 2016 and the broad market was going “sideways”. My response is simple, the broad market is in a downtrend, not a consolidation, and what’s working in 2016 is either really 1) defensive sectors like U.S. consumer staples, telcos, utilities, or 2) a dash for trash in some energy, material, retail and industrial stocks that got murdered in 2015. That is not bullish. And the reaction of a stock like Walmart (WMT) yesterday (to their full year guide down), and Deere (DE) this morning (on weak results), means we could be seeing and unwind of that second leg of “what’s working”. Both WMT and DE got murdered last year, and were showing relative strength in 2016.

A rotation out of banks and large cap tech into energy, materials and industrial based on NO evident improvement in company fundamentals or an uptick any global economic activity is merely bottom picking, not signs of a bullish turn by investors.

I would leave you with this chart, the equal weight  Value Line Arithmetic index, and equal weighted index encompassing about 1700 U.S. stocks.

From Bloomberg
From Bloomberg

This chart is a disaster. And even if you have been making money picking bottoms in beaten up stocks and sectors so far this year, this chart shows the distortion that a couple dozen stocks have had on the S&P 500 and the Nasdaq. It also shows a fairly clear topping formation when everything is equally weighted.  The index is in a downtrend, and just yesterday failed at the prior breakdown level.  If the index were able to make a series of convincing closes above 4100 then I might re-consider my bearish thesis near term, but not as long as the downtrend remains in place. This mindset is not too different than buying every dip on the way up from early 2012 to the spring on 2015, just in reverse.

I would also add that more troubling than the recent set up though is the late 2015 break below the uptrend that had been in place from the 2009 lows:

From Bloomberg
From Bloomberg

So I respectfully disagree with my panelists on Fast Money, that the relative out-performance of beaten up stocks after a 7 year bull market has broken is indicative of a possible turn back towards bullish sentiment. It’s nothing more than traders being traders. And as we’ve seen in WMT and DE, they’ll be gone as quickly as they came in at the first sign of trouble. To look at the internals of the U.S. stock market, breadth, new highs new lows, sentiment, I am hard pressed to take away any positives.  While cash on the side-lines among large U.S. asset pools will remain a theme for those who suggest the current correction may be shallow (my friend Brian Kelly addressed this topic this morning on the Ticker District here), I would point to the future need for sovereign wealth funds, whose wealth is getting creamed by the weakness in industrial commodities, to continue to liquidate U.S. stocks of which they hold so much of. Yesterday Bloomberg news highlighted the continuing liquidation of holdings of one of the largest wealth funds in the world in Norway, Norges Bank:

Norway’s central bank governor stepped up his warning on excessive use of the nation’s oil income as he predicted the government may need to withdraw almost $10 billion from its massive wealth fund this year.

Here is a snapshot of Norges latest reported holdings, from Bloomberg:

norges

That’s a lot of household U.S. stocks.  It may not be the health of the U.S. economy as to why your favorite large cap blue chip stock is being sold. It may have to do with some weird relationship of some far off land’s oil revenue and how that country had chosen to invest prior cash reserves in good times. And how they may need to tap said reserves to operate their country in bad times.

I have no idea from where it happens, but the selling that started in earnest here in the U.S. on January 4th is not done in my humble opinion. I remain in the camp that traders should sell rallies, and investors should use rallies to re-evaluate their portfolio and risk tolerance.