Seasonal Pattern or Change in Trend

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This was my technical view of things from last week’s piece: “The technical side of the market remains a range bound mess. False breakouts followed by false breakdowns shortly thereafter. The market remains extremely split. Roughly half the stocks in the S&P 500 are in sound shape technically. Please let me make this clear, the stocks that are not in good shape technically are getting punished. The gains in the broad indexes are covering the fact that many stocks have been in their own private bear market for months. Avoid the 'yeah buts.' Names that are rolling over technically are providing severe pain to people that make excuses for poor performers. Here are the intermediate resistance and support levels for the S&P 500/Dow/NASDAQ/Russell 2000: 1376/12,965/2990/822 and 1300/12,400/2800/748. Short term support levels are 1330/12,600/2850/775.”

Not much has changed. Things remain a range bound mess. The lows last Wednesday were as follows: 1333/12,534/2866/788. So, the short term support levels I gave last week held as indexes all closed above support as the final tallies for the day last Wednesday were 1341/12,604/2887/792. So, some of the levels gave way midday and then closed above the given support levels. That is a positive divergence. As things got underway Thursday the onus was moved to the bulls to come in and buy some stocks. What happened? The markets were weak again but from a near term technical perspective things began to look interesting near the end of the day. The various indexes flirted with support levels, some gave way intraday, but at the end of the day buyers came in and kept the pullback last week in the orderly range. Both the Dow and NASDAQ went below support levels intraday. The Russell 2000 and the S&P 500 held and a positive divergence developed and the market strengthened throughout the day setting the stage for the move higher Friday. Divergences need to be respected. Both positive and negative divergences need to be noted and dealt with. All the movement in the market last week confirmed that we are still in a trading range. Not the beginning of the end or the start of a new spike higher. With the short term levels holding last Wednesday and Thursday the move higher Friday was not surprising.

The market remains extremely split. There are a ton of names hitting new 52 week or even all-time highs. If you are focused on the wrong areas you are seeing names aggressively sold off. If there is a divergence—can’t seem to get away from that word—between your view on a stock and the markets, the market is always right. 

Where are we now technically? Here are the numbers for resistance and support for the major indexes on an intermediate term basis. This is an intermediate term gauge. If these numbers are breached it may lead to a sustained move. Resistance numbers are 1376/12,965/2990/822. Support for the major indexes are 1306/12,440/2810/752. Those numbers are a way off. Short term resistance is the same as for the intermediate term. Short term support levels are 1325/12,490/2896/777.

Often time’s people will make a declarative statement of fact in an attempt to show their wisdom. A good portion of that time while their statement is true, one can question its usefulness. As earnings season goes into full swing many will say this is going to be a tough earnings period and it is critical you don’t own stocks that will disappoint when they report earnings. Really! How is the different than any other quarter of any other year? There will be surprises out of left field in all earnings periods. If you see a stock selling off sharply in advance of earnings it could be a sign that the “smart money” is moving out ahead of you. This earnings season is perhaps going to be more difficult than average, but not a lot different. Names that are showing improvement and are beating expectations will be bought. If things are deteriorating and forward guidance is weak the stock will be sold. The theme they are pounding away with on TV right now is global growth slowing therefore stocks are going to perform poorly. Some will and some will not. Some globally based companies have rolled over and are in their own private bear markets. Others are breaking out to all-time highs. The point is to know the individual names you own and focus on their prospects and not be so focused on the market. There are several pockets of strength that are outperforming the market by a wide margin. Focus on the stocks with good and improving fundamental and technical trends. Based on the movement of the indexes last week the leaders should continue to be leaders. The pullback last week was orderly. Several market leaders came in early in the week last week and moved sharply higher from the lows of Thursday into the close Friday.

I wrote about a key theme in the market in a piece last year. Things are either getting better or they are getting worse. Change at the margin is how you get paid in the market. If a company reports record earnings, but the rate of change of growth has slowed, the stock will likely be sold and many will be left scratching their heads. Conversely, if a company reports earnings that pale in comparison to levels reached years ago, but better than current expectations buyers flock to the name. Things are either getting better or they are getting worse. Often times you gauge that by the current level of market expectations. Right now expectations are extremely low. The market is 4%-5% off recent highs and pessimism is extremely high. Negative earnings pre-announcements have spiked. So, based on where we stand entering earnings season I can make a bold prediction, if things are getting better for a company its stock will likely do well. If things are getting worse for a company the rout will be on. Don’t put a lot of stock in the articles that make blanket statements about the upcoming earnings season. We are in the summer doldrums and it is too early for the fourth quarter sprint to the tape. No different than second quarter earnings season in any other calendar year. 

From my perspective the debate is a clear cut one. Those in the bearish camp see the economy slowing down and predict that it is the precursor to a recession. Those that are more optimistic feel that the slowdown over the last several months is just that: a slowdown. A slowdown similar to the type we have seen over the past several years. They argue the slowdown is based on the spike in inflationary pressures we saw peak out around April this year. Energy prices were spiking, the markets were running, and then things cooled off. In the interim central banks around the world have fallen all over themselves in a race to see who can become the most accommodative. So, will the inflationary easing over recent months lead to acceleration in business activity over the remaining months of the year? Time will tell.

Here is one thing you need to ask yourself. If you see the economy slowing or you think things will rebound what should your response be? Is a 4%-5% decline in the markets a precursor to a recession? If you think so what do you do? Do you run for the hills and go to cash? Do you just load up on blue chips you are familiar with? Maybe somewhere in between would be prudent. If you feel that the economy is simply experiencing a typical seasonal dip you will use this uncertainty to step in and buy names as inflationary pressures gain steam going forward. First you need to determine what camp you are in and then determine what your portfolio should look like based on your overall view. 

If you own a portfolio of stocks you need to keep an eye on the names you own and not focus solely on the overall market levels. If you have names that are performing by all means keep them and prosper. If the names you own are rolling over, avoid the 'yeah buts,' and rotate toward strength.

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About Thomas J Smith CFA