If you look at the Russell 2000, we’re all good. Small-cap stocks have surged out of the low set earlier this month amid all that noise over emerging markets. The index is up nearly 10% since then in an unbroken 45-degree uptrend for the record books. It’s rare to see stocks whipsaw from a multimonth lows to a new high in such a short time.
Catalysts for the rebound included a Chinese bailout of that troubled “Credit Equals Gold #1″ trust just before the Lunar holiday, as well as the return of the “bad-news-is-good-news” mentality in which poor economic data is viewed positively since it means the Federal Reserve will likely keep the cheap money stimulus flowing.
But amid the melt-up, warnings signs are beginning to pop up suggesting investors should view the latest surge with skepticism. Here’s why.
For one, while U.S. equities are powering higher, the selling pressure has stealthily returned to emerging-market stocks with China’s Shanghai Composite falling below its 20-, 50- and 200-day moving averages after being above all three last week for the first time since early December. This comes as signs of stress returns to China’s interbank lending market, with swap borrowing rates blowing out to a record high over government bond yields.
Turkey is also back in the news as political turmoil involving embattled Prime Minister Recep Tayyip Erdogan returns. The Turkish lira is weakening in response — which was one of the main drivers of the market dump in January.
Also, some leading sectors, such as steelmakers, are rolling over here at home. Just look at stocks like U.S. Steel (X) and AK Steel (AKS) as they hang by their fingernails to multimonth trading channels. They look ready for a breakdown.
Moreover, safe-haven assets like the U.S. Dollar and U.S. Treasury bonds are enjoying some buying interest for the first time since January. The iShares 20+ Year Treasury Bond ETF (TLT) has jumped its 20-day moving average for the first time since early January as interest rates fall — ostensibly on the expectation that a recent softening in the economic data will continue. That pushes the TLT out of a month-long downtrend associated with the “risk-on” festivities in the stock market.
And finally, technical indicators are warning of trouble. Mainly, market breadth has been unimpressive as buyers focus on fewer and fewer stocks. Currently, the percentage of NYSE stocks above their 50-day moving average is peaking around 67% vs. a high of 72% in mid-January and 85% back in October.
It’s not for a lack of trying: As shown by the above chart of the nine-day moving average of the McClellan Oscillator (which is a measure of breadth momentum), buyers have reached exhaustion points associated with market tops in January, September, July, and May. The October-November melt-up is the exception here.
In response, I’m recommending investors use the environment to book profits in existing positions — especially precious metals positions that have done so well this month — and add a little short exposure to the areas of developing weakness. In the Edge Letter Sample Portfolio, I’m selling Great Panther Silver (GPL), Silver Wheaton (SLW) and the Global X Silver Miners (SIL) for gains of 18%, 6%, and 5.5%, respectively, while adding a position in the ProShares UltraShort FTSE China 25 (FXP).
For even more horsepower, I’m recommending put options against the iShares China Large-Cap ETF (FXI) to my Edge Pro clients. Specifically, the April $35 puts.
I’m also nibbling a little on some of the activity underway in the retail sector should the uptrend just keep blasting higher like it did in October and November. Examples include American Eagle Outfitters (AEO), which I’ve also added to the Edge Letter Sample Portfolio.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he has recommended AEO long, FXP long and FXI puts to his clients.