Weekly Market Commentary, Determining Direction
Investors are always staring into the unknown. As we consider our current portfolios, our thoughts naturally turn to what may happen in the future and whether or not we are properly prepared. At times, we can rely upon sentiment indicators and index levels to determine our next move. Other moments, we are left confused and must weigh the probability of what will occur next. Right now, confusion reigns.
As I have discussed in my Weekly Newsletter EPIC Insights and my weekly market commentary, my success in following this rally has been mixed. I correctly called for a rally in early March, but have been neutral over the past three weeks. During the past three weeks, stocks have moved steadily higher with the Dow Jones Industrial Average (Dow) rising over 4%.
Although the rise has been impressive and the index is currently trading above its 200-day moving average (MA), the increase has been sporadic. Seven days ago, the Dow closed at 8,740. Today it closed at 8,739. Quick drops have been offset by swift rallies and then a series of single-digit point moves, resulting in little overall movement with the Dow now 1 point lower over this time period. With such muted action, the past week can be viewed as either consolidation before markets push higher or a stalling rally that is set to fade. Making the right prediction will yield multiple profit opportunities, and therefore precision is key.
Unfortunately, precision is also lacking. Without clear patterns emerging, we must weigh probabilities and look for clues in the market. In order to determine the path of stocks over coming months, investors should focus on these three areas:
1. Sentiment indicators – Sentiment indicators measure the general feeling of market participants. Like a rubber band, when sentiment stretches too far in one direction we expect prices to snap back in the opposite direction. A broad array of sentiment indicators shows that markets are healthy, but not overextended. New highs are matching new lows, the NYSE bullish percentage of 74% has not reached overbought territory, 65% of stocks are above their 200-day MAs, and my proprietary model is 72% long with just as many stocks showing strength as weakness. These indicators paint a picture of a healthy market which should continue higher over coming weeks.
2. Fundamentals – I am always concerned with the values we find in the marketplace. When stocks bottomed in March, they were dirt cheap. Now they are more fairly valued. At the low, the Value Line median price-to-earnings (P/E) ratio was 10.1 and my research universe showed 62 stocks being undervalued. Now the P/E has increased to 14.9 and I find 24 stocks to be undervalued. Progress has been made. When you consider that the P/E at the market peak was 19.7 and I typically find fewer than 10 stocks to be undervalued, this market could continue higher. However, the easy gains have been made and relative valuation should act as more of a headwind over coming weeks.
3. Confirmation – Dow Theory relies on the movement of two indices to confirm a primary market move. I often look across 11 different indices. Recently, many of these markets have been moving to new highs, but four of them continue lagging: the Dow, Dow Transports, CAC 40, and FTSE 100. Until this issue is resolved, I will consider the select weakness as a possible indication of lower prices. However, should these four markets begin heading higher in unison, new market highs remain on the horizon.
Considering these three factors, I remain cautious. However, I am also very optimistic. Sentiment indicators tip toward higher prices and a potential confirmation would increase the odds of success. With fundamentals offering only slight resistance, we should be more attuned to strength than weakness.
For investors, the next few weeks loom as a critical juncture. For my clients, we will remain neutral with select short positions, but will monitor these three indicators. Were the four lagging indices to confirm the bullish moves of the stronger, I would consider that a signal to begin adding equity exposure. Having missed the last four weeks of the rally has been frustrating, but being prepared to act in a constructive manner will allow us to make up for lost time.
Sean Hannon, CFA, CFP is a professional fund manager. He runs EPIC Insights Weekly, the free Sunday newsletter, and also is the founder of EPIC Advisors, LLC. View Sean’s Full Bio.
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