What a difference a week makes: Stocks have roared higher over the past five trading sessions to push the Dow Jones Industrial Average back above the 18,000 in mid-day trading on Friday. All the fear and uncertainty surrounding the surprise “Brexit” vote last week has faded faster than what even the most ardent market bull could’ve hoped for.
The catalyst has been a massive short squeeze (biggest since May 2009) and the move aggressive dumping of volatility hedges in history. The CBOE Volatility Index has dropped harder and faster than after the Gulf War, the recovery from the Bear Stearns collapse, and even the fiscal cliff rebound.
Friday’s gains were relatively tepid, as traders held a little back going into the three-day holiday weekend.
In the end, the Dow Jones Industrial Average gained 0.1%, the S&P 500 gained 0.2%, the Nasdaq Composite gained 0.4% and the Russell 2000 gained 0.4%. Treasury bonds were stronger, the dollar was weaker, gold gained 1.4% and oil was 1.3% higher.
The S&P 500 has gained 3.3% over the past week, its best performance since October 2014. The weakest, most shorted stocks are up 10.1% over the last four days, the biggest short squeeze since May 2009. Financial stocks have enjoyed their strongest rise in three months.
But will the gains continue?
To be fair, as the dust settles it looks like Brexit may not be as catastrophic an event as was initially feared. In the best traditions of European bureaucracy, the process will likely take years and will be debated, discussed, and legislated until ennui takes over. Capital Economics also noted the rising possibility that Brexit actually won’t happen, with Scotland and Northern Ireland supporting “Remain” and the British government in no hurry to invoke the Article 50 exit clause.
And there is some contrarian evidence that investors overall remain too skeptical.
Yet, I continue to see warnings signs.
Fundamentals remain terrible with an ongoing corporate earnings recession, trying valuation multiples for equities, uneven economic data, massive leverage and indebtedness, a tightening U.S. labor market that is forcing the Federal Reserve to keep rate hikes on the table, and a contentious U.S. presidential election.
Outside of equities, other markets are warning of trouble.
Silver gained another 5.2% today as both the bond and precious metals markets continue to belie the confidence in equities. Their rise suggests growing expectations of a return of currency market volatility and the likelihood of an inflation breakout as central banks become ever more aggressive in their support of financial markets.
The rise in the grey metal boosted the July $17 SLV calls to a gain of 314% for Edge Pro subscribers since the position was first recommended on June 24.
And stock market breadth remains unimpressive. Just look at the way bank stocks rolled over today and remain within the confines of a medium-term downtrend. The recent rally in long-term government bonds — spurred, ironically, by hopes of more aggressive monetary policy stimulus — has narrowed the net interest margins banks rely on for profitability.
Overall, just 53% of the stocks in the S&P 500 are in uptrend vs. 74% in early June and nearly 80% back in April when the Dow was trading 250 points lower. This narrowing base of support shows the bulls are relying on a narrowing group of stocks to keep the major averages aloft — not exactly a sustainable situation.
Watch for the selling pressure to resume when traders return on Tuesday, not because of Brexit, but because of a return of old, familiar worries that have kept a lid on stock prices for the last three years: Falling earnings, tepid growth, and the specter of Fed rate hikes.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
