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Since November 2012, the S&P 500 has remained above its 200-day moving average for 421 consecutive trading days, the longest streak in history. I have compared this streak in the S&P 500 to the Joe DiMaggio hitting streak in 1941 for its incredible consistency and resiliency.
The so-called “path of least resistance” has been up and if you are a long-term trend-follower focused on large cap U.S. equities, this has been the best period in history for your strategy. But no trend lasts forever and strategies come into and out of favor over time as the market environment changes.
I know it has become blasphemy to question this historic advance, but I am wondering aloud here if we are about to take the road less traveled, that is the one back to the 200-day moving average as the market environment is slowly changing. Last week, as the S&P 500 hit yet another all-time high, there were a growing number of red flags that indicate that the probability the streak may soon be in jeopardy is at its highest point since it began in November 2012.
Let’s have a look:
The credit markets are showing signs of weakness for the first time in months. High Yield credit spreads have been consistently widening since late June and are close to a 3-month high. This has been a minor move higher in spreads thus far, but as credit typically leads, one that should not be ignored.
European credit spreads have also been widening, notable in my view as we are seeing this credit weakness in the face of what was supposed to be a highly positive event: a move to negative interest-rate policy. As I questioned recently, what is it telling us when negative rates are not enough?
Small Cap weakness has been a nagging red flag this year and it continued last week as the Russell 2000 closed out the week at its 200-day moving average. In a stark divergence from the all-time highs in the large cap indices, the Russell 2000 is actually down year-to-date. The weak behavior in the average U.S. stock is being masked by the strength in the largest stocks.
Similarly, breadth did not confirm last week’s new highs with the NYSE Advance/Decline peaking back in early July.
We are also seeing persistent weakness in housing, with homebuilders down over 7% on the year and hitting new relative lows last week. It is notable that this weakness has persisted in spite of a decline in yields this year and in spite of the market not expecting the Fed to raise rates for at least another year.
As I have noted in writings showing the many parallels to 2007, we continue to see late cycle sector behavior with Energy/Utilities leading the market higher while the most cyclical sector, Consumer Discretionary, is lagging. You rarely want to see this type of defensive backdrop this late in the economic cycle. The persistent strength in Utilities is particularly notable because it tends to precede more difficult market environments, as we outlined in a research paper earlier this year.
In the past two weeks, I have also noted the divergent behavior in the cyclical Industrials sector, which hit new relative lows and failed to hit a new high with the S&P 500 last week. The last two corrections, in 2011 and 2012, were both preceded with Industrial sector weakness.
Long duration (30-Year) bond yields have been falling for the entire year, and hit a new YTD low last week at 3.2%. This behavior indicates that investors are seeking out the safety of Treasuries, likely anticipating more difficult times ahead.
It is not simply that yields are falling that is a problem, but the behavior within the Treasury market as well. The Yield Curve hit new YTD lows last week as the demand on the long end is outpacing demand on the short and intermediate end of the curve. This defensive behavior tends to precede more difficult market environments, which we wrote about in another research paper this year.
Collectively, the market is sending signals of caution while the large cap indices are hitting new highs. In markets, we deal with probabilities, never certainties, and the probability of the S&P 500 finally taking the less traveled road to the 200-day is rising. That probability is not anywhere near 100% but it is high enough to warrant our attention, particularly as we approach the end of QE in October and as long-term stock/bond returns are unattractive at current valuations/yields (see Has the Fed Doomed Buy and Hold?).
Does this mean that the bull market that began in March 2009 has to come to an end? No, and as I have written many times in the past, picking an exact top is impossible and not particularly helpful to long-term investors. What it will mean is that we are returning to a more normal market environment where corrections exist and risk management matters. Such an environment should favor more active, tactical management.
For our part, we rotated to a more defensive posture last week in our mutual funds and separate accounts. It remains to be seen if the red flags outlined above will persist, but as long as they do the long-term probabilities favor defense over offense.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers on Intermarket Analysis. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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