The following is an interview with noted market technician Tom McClellan, who has been consistently ranked as a top market timer and analyst for gold, bonds, and the stock market[dot]
Tom is still bullish on U.S. stocks and sees valuations continuing to stretch further. He also notes that oil has just gone through a post bubble-like collapse and will remain low for at least another year or more. On gold, Tom says that large commercial traders (aka, “smart money”) have closed out a significant portion of their short positions, which is a bullish sign. That said, he believes gold’s current rally will probably have a “limited life expectancy” until August of this year when it reaches a major cycle bottom.
The following is a transcript of his interview that recently aired on Financial Sense Newshour at the 18:25 mark here.
Tom, year-to-date the major U.S. stock market indices have not made a lot of progress and have also seen a moderate amount of volatility. The S&P 500 was down 3% at the start of February, up nearly the same amount a month later, and is now just slightly above 1% for the year. What do you make of the little progress and volatility we’ve seen so far?
“That’s true if you look at the large cap U.S. markets. If you look almost anywhere else, it’s been a pretty nice quarter for the year. European and Asian markets are up if you look at them in their own currencies. If you look at them measured in dollars it is not so good because the dollar has been screaming upward. If you look at small caps in the U.S., they’ve had a nice quarter. It’s mostly in the big cap indices that we’ve seen that back and forth going nowhere that you mention.”
If you look at returns for the year, they’re a little better for the NASDAQ and the Russell 2000, which is reflecting what you just said. Do you think that has a lot to do with domestic companies versus the large-cap international companies that are being hurt by a rising dollar?
“Usually in past eras a rising dollar has been bad for small-cap companies because they are less stable to hedge and they’re less diversified in terms of their overall sales. You know, if Coca Cola sees one country up and another one down, it all pretty much balances out, but if you are a little tiny tech company and you suddenly can’t sell overseas because the dollar is up so much, then the small company gets hurt more. But that’s not what we keep hearing people talk about these days. They keep thinking that the rising dollar is better for small caps and hurts large caps. I don’t know if there is enough thinking that’s going on behind all those comments that you hear in the media. What I can say though is when you have small-cap outperformance like we’re seeing and especially outperformance by small-cap growth stocks versus value stocks that condition tends to be the most bullish condition for the overall market in the long run because it tells you that there is plenty of money to go around. The small cap growth stocks are the least deserving stocks of any investment money. So when they can be outperforming and when there is enough money around to help lift those, that’s a sign that there is enough money going around to help lift everybody. When you see those guys start to suffer, that’s like the canary that dies in the coal mine from the bad gasses before the big burly coal miner and that’s a warning to get out. We’re not seeing that warning now. We’re seeing small-cap outperformance, which is a bullish vector.”
And Tom, what about the non-confirmation between the Dow Industrials and the Transports? Does that have any significant meaning in your opinion?
“No. That’s the short answer. It used to a hundred years ago but right now the Dow Transportation Average is dominated by airlines… It’s not the same thing now even though the name is still the same.... It is not the same thing that Charles Dow talked about a hundred years ago when you were looking at industrials and rails. So people shouldn’t get suckered into thinking it works the same as a hundred years ago.”
So let’s move on to some of the markets that have done well; the NASDAQ is up 4% percent and the Russell 2000 is up 4.5% so far this year. If you look overseas, the German DAX, the Euro Stock Index, and even the Nikkei are all up double-digits this year. What does that tell you when you have global participation?
“Well, it’s good for those guys but most of that is being driven by changes in currencies. If you look at the Nikkei, which is expressed in units of Japanese yen, it looks great. If you factor out the yen/dollar exchange rate differences, the outperformance of Japan’s market goes away quite a bit. So Japan’s market is doing really well because the Japanese are torpedoing their own currency in hopes that will help their economy, even though that hasn’t worked yet. Europe is going the same. Europe is benefitting from two factors which is the value of the euro going down, and thus making their exports more attractive, and also Western Europe is an oil importer. So Western Europe gets the benefit of lower oil costs, whereas in America we’re both an oil consumer and an oil producer, so it’s a much more balanced change in terms of what the effect is on America. It’s much more the other way for Europe. If you see oil going the other way though, and going back up to a hundred dollars a barrel, which I don’t foresee, than that would hurt Europe more than it would hurt us. So it’s a two-edged sword.”
So with this congestion that we have in some of the larger cap stocks, what is giving you optimism is the outperformance by the small caps and that is a very bullish stance for the market in your opinion?
“Yes, that’s true and…we’ve been seeing new home sales going up and people getting into auction and bidding situations for the limited number of homes for sale, so that’s actually a positive for the stock market because the real estate market will tend to peak ahead of the stock market. At least that’s the way it’s worked through the last several major market cycles. Remember, the housing bubble peaked well ahead of the stock market bubble in 2007. We’re not seeing any sign of a peak in the housing market yet in the rearward looking numbers. However, looking forward, I’m persuaded by the weakness that we have just been seeing in lumber prices that we are going to be seeing some housing weakness coming over the next year, about the next twelve months, and eventually that’s going to come around and bite the stock market. But there’s a big lag between when you first see housing weakness appear in the housing numbers and when that finally comes around to hurt the stock market. So yes, there are signs that there may be coming trouble someday, but not yet to the point where you have to worry.”
So when we’re looking out further, some possible weakness in housing, which could come back to bite the market. Anything you’re seeing right now that stands out in terms of specific sectors in the S&P?
“Well, small-cap growth is not within the S&P and that’s looking the strongest right now. Consumer discretionary is acting very strong. People should be aware though that some of the biggest stocks within that consumer discretionary S&P sector are media companies… That’s an interesting anomaly in the way that those indices are constructed, but yeah, we’re not seeing this tailing off of performance in consumer discretionary that you typically see before a bear market. We’re not seeing the financials do poorly, which they will usually peel off and start heading lower before a bear market comes around. We’re not seeing that yet. And we’re in the fat part of annual seasonality. April is typically a very strong up-month and I expect it to be this time. We’ve all heard the expression about ‘sell in May and go away’; well, it’s actually sell in June because that’s when seasonality peaks out. But you can’t create a phrase that rhymes with June quite as well as with May so that’s why people still say, ‘sell in May and go away.’”
Do you expect that pattern to show up this year? In the last couple of years we haven’t seen “sell in May—or sell in June—and go away” play out. Do you think this year will be different?
“Well, we’re in the third year of a presidential term. April is typically a strong up-month in the third year of a presidential term. And when we have a second term president, as we do right now, the market typically peaks in July. The current pattern of the S&P 500 is correlating very, very well to the presidential cycle pattern for second term presidents that we talk about in our newsletter. And so I expect that correlation to continue and I would look for strength until July. We’ll see how that strength itself unfolds and what the breadth numbers are saying and what the other indicators are saying once July arrives in order to say what the summer might look like, but we’re not yet to the period when you look for a sideways market that you just want to get out of the way of, or in the middle of an uptrend with higher lows and higher highs even for the S&P 500. So I expect that to continue.”
Let’s talk about commodities next. What are your thoughts on oil and gold?
“Oil is probably going to stay depressed for about the next year or so. It’s been following the pattern of the bubble collapse that we saw in gold prices back in 2013. If you recall, gold peaked up at 1900 and then it dropped all the way down to about 1100. The same path—the way that price pattern behaves—has been repeated in the oil market and so going forward, we’re now at the point of that whole script where gold was going sideways and that says that oil should be going sideways for a while. And if you look at the news about supply and demand, people are still buying Priuses even though gas prices are down. The number of rigs is starting to decline but there’s still more oil coming on the market. And Saudi Arabia still wants to squeeze Iran out of things so it’s not going to let up on its production. So we’re looking at plenty of fundamental reasons and plenty of technical reasons for oil prices to stay down here. Looking at gold though right now, the biggest most compelling factor I see is in the Commitment of Traders Report data where we see the commercial traders, those are the big smart-money guys, they have dropped their short positions in a huge way down to a low enough level to say that gold ought to have bottomed and head upward, and it seems to be doing that right now.”
Given what you said about gold, do you expect to see the dollar weaken much further then?
“That’s a funny question because American investors typically think about gold and the dollar moving inversely; and it’s natural that we would think that way. But American investors in gold have not been the driving force. The instances where gold has seen strength in the last year or so have been instances when the euro was suddenly getting weak and euro-based traders, people who think in euros, were suddenly seeing the need to hedge their own wealth positions in their own currency so they were turning to gold. So looking at the price of gold measured in euros gave us much better technical indications than looking at it in dollars. In fact we saw a big burst in gold a couple months ago at the moment when the euro price broke out above a thousand euros. It had been lurking just underneath a thousand and the round number effect works on European brains just like it works on American brains. Once you see the price of gold going from three digits to four digits, that gets everybody excited and they all piled in. It’s the euro price that seems to matter more than the dollar price which is hard for Americans to get their brains around because we are so used to thinking of it in terms of dollar versus gold. But you have to learn to think like a European if you want to think correctly about what gold is going to do.”
So given the fact that the ECB has launched quantitative easing, do you think that should put some downward pressure on the Euro and be good for gold?
“Well, more importantly, the size of the ECB’s balance sheet is very strongly correlated to the euro price of gold. It doesn’t correlate as well to the dollar price of gold. So the expectation is that if indeed they are going to increase the size of their balance sheet by that billion euros a month, as part of their new QE program, that should move up the euro price of gold as a corresponding way of how that correlates. Now, how much of that flows through to the dollar price of gold is a double question because then you have to answer, well, what is the dollar and the euro going to do as part of all that? And that gets to be a much more complicated question. For right now though, the dollar price of gold is in an uptrend, and it should continue to be in an uptrend based on what the smart money guys are saying in that Commitment of Traders data. And that’s about as far as I’m willing to extend myself in predicting what might happen to the dollar price of gold for the next few months. It should rally, but there is a major cycle bottom in gold prices due in August of this year. So any rally that we see starting just a few weeks ago only has a limited life expectancy because we should see a more significant turn down as that major cycle bottom gets closer.”
So, Tom, as you look at the charts, cycles and drivers for this market, is there anything that really stands out or pops out to you right now?
“Small cap relative strength, strong advance-decline line, Fed still on the sidelines and sitting on its hands—those are all traits that say, ‘This is still an uptrend and we should ride it for all it’s worth.’ It’s not yet the time to start worrying about protecting our money. It’s time to ride the market. Even though the market is overvalued, it can stay overvalued for a long time and it seems to be doing that.”
Listen to this full audio interview with noted market technician Tom McClellan on the Newshour page here or on iTunes here. Subscribe to our weekly premium podcast by clicking here.
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