Weekly Market Outlook - Is This Market Too Good For Our Own Good?

Posted by jbrumley on February 19, 2017 3:55 PM

021917-trendscoreIs there anything the bears can do to stop the bullish train? It certainly doesn't look like it. The market roared (again) last week, shrugging off the glimmer of weakness that reared its head on Thursday to end the week at a record high close... and just a hair away from another record high.

If nothing else, it's a market marvel. The S&P 500 is now up 10.6% since the end of October, and is up 12.8% since the early November low, making this one of the biggest (and fastest) uninterrupted rallies ever. Something's got to give soon, or does it?

The good news is, a ceiling we well defined last week. That, coupled with the simple fact that the market s overvalued and overbought, could mean a sharp pullback is finally in the cards. Nevertheless, though meltups are rare, they can and do happen. You don't want to step in front of one on principle.

We'll weight it all below after a look at last week's and this week's economic news.

Economic Data

Plenty of economic news to sift through last week... perhaps too much.

The first in a string of data reports was last month's inflation data - producer and consumer. As suspected, both were up, on a core as well as a non-core basis. In fact, both were up by more than expected, establishing some pressure for the Federal Reserve to move faster with 2017's planned interest rate hikes than perhaps it was initially counting on. This needs to be tamed, fast.

Producer and Consumer Inflation (Annualized) Charts
021917-inflation
Source: Thomson Reuters

Last month's retail sales were nothing less than outstanding, growing no matter how you stratify it. More important, the growth pace is improving again after 2015's lull and 2016's uncertainty.

Retail Sales Growth (Annualized) Charts
021917-retail-sales
Source: Thomson Reuters

Not every nugget of economic data was as encouraging as last month's retail spending would suggest, however. January's industrial productivity was off a bit, as was capacity utilization. This data set tracks earnings very well (for better or worse), and as a results tends to correlate very strongly with the market's long-term trend. The lackluster trend here hints that stock prices are getting a little ahead of themselves in terms of valuation. We need to see both of these trends tick higher... soon, and decidedly.

Capacity Utilization and Industrial Productivity Charts
021917-productivity-capacity
Source: Thomson Reuters

Housing starts and building permits could have been better, though aren't exactly 'troubling' yet. Mostly it looks like the real estate market is cooling a bit without ever reaching 2006's red-hot levels. As long as this data doesn't start trending lower, we'll be ok.

Housing Starts and Building Permits Charts
021917-starts-permits
Source: Thomson Reuters

Everything else is on the grid.

Economic Calendar
021917-econ-data
Source: Briefing.com

This week won't be nearly as busy, though there are some items on the schedule worth keeping an eye on.... particularly on the real estate front. After last month's so-so starts and permits report, this week we'll hear January's existing home sales and new-home sales numbers. Economists are looking for modest improvements on both fronts. You may recall both hit a sizeable headwind for December, so we need to see progress here.

New and Existing Homes Sales, Inventory Charts
021917-home-sales
Source: Thomson Reuters

A lack of inventory may or may not be holding the market back. We'll get a clearer picture on that front by the end of the week.

You can also count on fireworks following Wednesday's release of the minutes from the most recent meeting of the Federal Reserve's governors held at the end of January. It will be interesting to see what the members were seeing on the inflation front before they were aware of January's inflation surge. They may not have known then how quickly prices would soar last month.

Index Analysis

As of Friday, the market's gone 88 straight day without a daily loss of 1% or more. That's the longest streak since 2006.This is also the best 'first February' for a new Presidential term since Lyndon B. Johnson. And let's not forget that the trip the Dow Jones Industrial Average made from 19,000 to 20,000 as of late-January was the second-fastest 1000-point move the blue-chip index has ever made, and it's holding that pace - the Dow is presently at 20,624. That's closer to the next 1000 point level than the one recently hurdled.

From a momentum perspective (and we're mostly momentum traders), it all says "full speed ahead." From a common-sense perspective though, this heroic move leaves some investors terrified of just how bad things could get when - not if - the bubble is popped.

The challenge: Timing. Until the bulls are ready to switch gears, it's difficult to stand in their way. That time should be coming soon though.

We mentioned it last week but it bears repeating now - the market (using the S&P 500 as our proxy) is overextended. The index now sits 7.8% above its 200-day moving average line, which is well beyond the normal degree of separation it can muster. Our weekly chart tells the tale.

S&P 500 Weekly Chart
021917-sp500-weekly
Chart created with TradeStation

Zooming into a daily chart of the S&P 500 we can see some more detail about the rally, for better and worse.

Though Friday's close was a record high close and within easy reach of the record high achieved on Wednesday, a ceiling seems to have formed at 2353. Maybe this is just a ceiling that allows the buyers to regroup before beginning the next leg of the rally. Or, maybe the bears have drawn a line in the sand there.

S&P 500 Daily Chart
021917-sp500-daily
Chart created with TradeStation

It's a conundrum to be sure. We're new deep into buy signals from the PercentR line and the MACD indicator, which in most other situations would be decidedly bullish. The BigTrends TrendScore for stocks is also in the high 90's.... almost to 100. We couldn't ask for more bullishness.

S&P 500 Daily Chart, With PercentR and MACD
021917-sp500-percentr-macd
Chart created with TradeStation

Like we said, it's a conundrum. This rally is built on the euphoria stemming from the promise of tax relief and a pro-business President, but we haven't actually seen any fiscal benefit from his policies (they haven't had time to take hold yet). The trailing P/E for the S&P 500 is an eye-popping 21.5... a value that's tough to justify in any situation.

Maybe earnings will indeed catch up with valuations. Indeed, maybe they are already starting to catch up with valuations. Sooner than later though, companies are going to have to start proving it. Also notice that the volume behind the recent rally has been just mediocre.

With that being said, don't presume the rally's going to falter right away. To stop this advance dead in its tracks, traders are going to have to have a very clear, tangible reason for a course-reversal. Otherwise, the default assumption remains "full steam ahead," and not being in stocks is a mistake.

That being said, for the S&P 500, clearly 2353 is a ceiling. A move above that mark could incite a little short-term bullishness, but don't be shocked if it fizzles quickly. Conversely, keep an eye on the 20-day and 50-day moving average lines for the S&P 500, and the lower Bollinger band, Any and all have the potential to serve as a floor. More than anything though, keep an eye on the VIX.  If it starts to trend higher and hurdles its recent ceiling around 13.0, that's a strong signal the rally has run its course and traders are switching from offense to defense.

BECOME A BIG TRENDS INSIDER! IT’S FREE!