The market is standing at the proverbial “crossroads” of bull and bear. From a “fundamental” perspective there is not much good news. The past week we saw numerous companies beating extremely beaten down estimates. However, while JPM and C got a boost to their stock price, the actual earnings, revenue and profits trends were clearly negative. But that is the new normal. We live in an environment where Central Banking has taken control of financial markets by leaving investors “no option” for a return on cash. Therefore, the “hope” remains that asset prices can remain detached from underlying fundamentals long enough for them to catch up.
As the trumpets sound to signal the start of earnings season, the battle between fundamentals and “hope” begins.
The stock surge from February is at risk, warns BofAML's Stephen Suttmeier as a plethora of bearish divergences could cap further gains from here. 2044-2022 are key nearby S&P 500 support for April, but a loss of 2022 is required to break the last higher low from 3/24 and suggest a deeper decline for the S&P 500. The following 15 risk-factors - from VIX term structure steepness to Dow Theory Sell signals - all point to a retest of the recent 1810-1820 lows.
"Should the S&P 500 “The Generals” follow the weakness in the Value Line, NYSE, Russell 2000, and S&P Midcap 400 “The Troops”, there is risk below 1812-1810 toward 1730 (38.2% of 2011-2015 rally) and then 1600- 1575."
While the S&P 500 held support at January low (1,812) yesterday (and October 2014's Bullard bounce lows), BMO's Russ Visch warns "it may not hold in the days ahead" due to weak market breadth.
The deterioration of the indicators highlighted below point to a downside break for the late-stage cyclical bull market from 2009, according to BofAML. Should 1,867 decisively give way, the 1820 (October 2014 low) provides additional support but the bigger risk is a top that projects down to 1,600-1,575; and derspite the last 2 days' bounce, volume and breadth suggest a market under distribution or selling pressure, not primed for new highs.
Weakness in Breadth, volume, sentiment, and momentum all lead BofAML to warn "sell rallies" in stocks. Starting 2016 under pressure, the S&P 500 has big support at 1994-1990 but 1965 is the level at which things become perilous. Simply put, holding 1965 is required if a 'bounce' like late 2011 is expected.
The problem of suggesting that we have once again evolved into a "Goldilocks economy" is that such an environment of slower growth is not conducive to supporting corporate profit growth at a level to justify high valuations. Such a backdrop becomes particularly problematic when the Federal Reserve begins to raise interest rates which removes one of the fundamental underpinnings of an overvalued market which was low interest rates. Ultimately, higher interest rates, particulalry in an economy with a deteriorating economic backdrop, becomes the pin that "pops the bubble." It is true that the bears didn't eat Goldilocks at the end of the story...but then again, there never was a sequel either.
"Clients are quick to point out similarities between the current low breadth environment and the narrow breadth regime that emerged during the tech bubble in the late 1990s. Our Breadth index currently equals 1, one of the lowest levels in the 30- year series. The typical episode lasted four months, with past episodes ranging from two months in 2007 to a high of 14 months during the tech bubble."
If one looks at the NDX alone, one would have to conclude that the bull market is perfectly intact. The same is true of selected sub-sectors, but more and more sectors or stocks within sectors are waving good-bye to the rally. Even NDX and Nasdaq Composite have begun to diverge of late, underscoring the extreme concentration in big cap names. Naturally, divergences can be “repaired”, and internals can always improve. The reality is however that we have been able to observe weakening internals and negative divergences for a very long time by now, and they sure haven’t improved so far. In terms of probabilities, history suggests that it is more likely that the big caps will eventually succumb as well.
The first change often occurs below the surface. The deterioration of the market’s internals typically occurs in the lead-up and development of a cyclical market top, but this dynamic too can persist for an extended period. However, eventually these divergences reach a head, and the most egregious cases have historically occurred within close proximity to major, cyclical market tops. The deterioration of the broader market is so great that the resultant foundation of support below the surface of the popular market cap-weighted averages is nearly non-existent. Once the relatively few leaders propping up the market begin to collapse under the weight, the inevitable cyclical decline can commence.
"The combined levels of bullish optimism, lack of concern about a possible market correction (don't worry the Fed has the markets back), and rising levels of leverage in markets provide the 'ingredients' for a more severe market correction. However, it is important to understand that these ingredients by themselves are inert. It is because they are inert that they are quickly dismissed under the guise that 'this time is different.' Like a thermite reaction, when these relatively inert ingredients are ignited by a catalyst, they will burn extremely hot. Unfortunately, there is no way to know exactly what that catalyst will be or when it will occur. The problem for individuals is that they are trapped by the combustion an unable to extract themselves in time."