Why Stocks Are Due For A Pause

Market Summary

Earnings Season also unofficially begins with the release of Alcoa’s (AA) results on Monday. However some investors remained concerned about the effects of "Brexit" and the upcoming earnings season. Near record lows in 10- and 30-year U.S. government bond yields underscored those concerns. "I am maintaining a cautious outlook for the next couple of months," said Phil Orlando, chief equity market strategist at Federated Investors in New York, citing Brexit, uncertainty about rate hikes and the November U.S. presidential election. "I think investors are just whistling past the graveyard here; there is a lot of ugly stuff on the horizon that everyone is just sort of ignoring. It just strikes me there are just too many things that can go wrong over the next couple of months."

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. The updated chart below displays stocks recent uptrend. However the orange circles denote overbought levels where in the past the market advance consistently has stalled out. We recentlydiscussed how investors overreacted to the Brexit vote and oversold stocks and therefore the market was due for a robust bounce back from the Brexit selloff. Technically and fundamentally the major indexes are due for a pause. Stocks are overbought and buyers will probably sit tight ahead of quarterly earnings season that kicks into high gear in a few weeks. Usually price action is subdued at the start of earnings announcements, plus most investors don’t want to get overly aggressive until they can get a read on what the FOMC will decide at their next meeting in a few weeks.

Trading Strategy

According to the Stock Trader’s Almanac the average price tendency is for a summer sell-off that usually begins in mid-July and lasts until mid-October. Part of the reason is perhaps due to the fact that July starts the worst four months of the year for NASDAQ and also falls in the middle of the worst six months for DJIA and S&P 500. Mid-July is also when we typically kick off earnings season, where a strong early month rally can fade, as active traders may have “bought the rumor” or bought ahead on anticipation of good earnings expectations and then turn around and “sell the fact” once the news hits the street. Our recently analysis was realized where we asked, “…Now the question is where will the market bottom out? The best bet is that investors overreacted to the Brexit vote and stocks will eventually bounce back, especially since some pundits believe there is a possibility the FOMC could lower rates at one of their upcoming meetings. If this prediction comes to fruition the current pullback might be great opportunity to bid on undervalued shares...If the market does pull back, that might be a good opportunity to “buy the dip” with shares in the leading sectors…” We discussed above our prognostication suggesting the market is due for a pause. If this analysis plays out that might be another opportune time to bid on shares in “risk-off” defensive stock groups such as Consumer Staples, Health Care and Utilities which have been leading the market higher over the past month.

By Gregory Clay

Investment Strategist

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gregoryclay@nellaadvisors.com

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