Monday, October 6, 2014

The Market's Next Move

Market Outlook
September began in typical fashion this year, early strength that lead to mid-month new market highs and it also finished rather typically. The week after September options expiration week was down and then end-of-third-quarter window dressing saw major averages decline even further. The S&P 500 enjoyed its biggest one-day gain in nearly two months, while the Dow Jones Industrial Average tallied its biggest gain in seven months, thanks in large part to a stronger-than-expected jobs report that delivered a dose of confidence to investors. Friday’s rebound put a dent in weekly losses, but the main benchmarks still finished the week modestly lower marking the second weekly decline in a row for major indexes.

Previous Weekly Setup commentary mentioned “…We expect volatility to increase over the next two months from the current historical lows including another price pullback…Don’t be surprised if September starts strong…But the market begins to fade as money managers’ start selling off losers and repositioning assets for the end of the third quarter window dressing…This prognostication is playing out as advertised…” 

We pointed out recently “…the Russell 2000 index dropping into negative territory for the year.  You would prefer to see all the major indexes breaking out to new highs to have confidence in a bullish move. Small caps underperformance is an indication of investors wanting to avoid riskier trades at stocks current frothy levels…The updated graph below supports our previous analysis as last week all the major stock indexes followed the Russell 2000 lower…” The obvious question at this point is whether the market will follow through on Friday’s price recovery. As you can see in the updated chart below the Dow Jones Industrial Average is in danger of following the Russell 2000 index into negative territory for the year.

The Stock Traders’ Almanac reported that a mid-September breakout failed rather quickly and DJIA, S&P 500 and NASDAQ are once again trading in a choppy sideways pattern. All three indices are currently trading around their respective 50-day moving averages. The Russell 2000 is having the hardest time. Its 50-day moving average has crossed below its 200-day moving average, the dreaded “death cross” and it is currently flirting with its early August intraday lows. Since Russell 2000 does have a tendency to lead on the way up and the way down, its technical picture warrants attention, however it is behaving in typical seasonal fashion by underperforming through the third quarter. If seasonal trends hold for Russell 2000, a bottom sometime in October is anticipated.  October is the last month of the “Worst Six Months” for DJIA and S&P 500 and the last month of NASDAQ’s “Worst Four Months”. Frightful history of market crashes aside, October has been stellar in midterm years, number one month for DJIA, S&P 500, NASDAQ and Russell 1K, number two for Russell 2K. Keep an eye out for the Official MACD Seasonal Buy Signal. It can trigger anytime on or after October 1.



Investor Analysis
Next week aluminum maker Alcoa kicks off the unofficial start to corporate earnings season. It is reasonable to expect the next few weeks will probably be similar to early April and July when price pullbacks were a prelude to a pickup in quarterly earnings announcements where investors bid stock prices back up. We have saying recently “…the Worst Six Months, May through October have only averaged a 0.3% DJIA gain since 1950 versus a 7.6% average gain during the “Best Six Months”, November to April. For S&P 500 the gain is slightly better at 1.3% during the “Worst” and 7.1% in the “Best” over the same time period… before the Best Months begin the market still has to navigate weak end-of-Q3 seasonal factors and the frequently troublesome month of October. With solid fundamental data and an accommodative Fed at its back, any market dips between now and the end of October are likely to be a great entry point for the next “Best Six Months” cycle…”

Earlier in the week, investors were rattled by a sharp drop in small-company stocks, pro-democracy protests in Hong Kong, and falling oil prices that hurt energy companies, big components in stock indexes. The worst performing market sectors for the third quarter in the graph below have been hurt by the exceptionally strong dollar and investors becoming more risk adverse. Treasury bonds and financials are benefiting from Federal Reserve’s low interest rate environment and technology stocks remain strong based on investors’ future growth expectations.



By Gregory Clay
Investment Strategist

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