As we discussed last week, a relatively small group of stocks contributed a large percentage of the major indexes’ recent gains. That’s still true this week, with the second-biggest gains in the stock market coming from the business-technology and software segments. Surprisingly, the largest gains this week — and this month, so far — came from energy stocks as oil prices have continued to rise.
When a small group of stocks is driving the market’s gains, it indicates that market “breadth” is narrow. That’s concerning because these rallies are prone to reversals.
In this case, there are 24% of the stocks in the S&P 500 trading above their 200-day moving average, and 21% of the Russell 2000’s stocks are above that same benchmark. Market breadth, while narrow, is a bit better than the average after other big drawdowns, so we aren’t too worried about the small circle of market leaders.
But there is still plenty of evidence to justify a very cautious outlook. So far, earnings across the S&P 500 are down about 13.7%, with approximately 55% of the companies in the index reporting. If that is close to the actual average by the end of earnings season, it would be the worst decline since the worst quarter of 2009, which would be alarming.
A significant percentage of the losses so far have come from financial stocks. According to Factset, earnings growth is down about 42% in the financial sector, which is usually a reliable bellwether for the rest of the market.
From a technical perspective, the trends across the major indexes are positive. We have continued to take advantage of that with our bullish positions by rolling out our options to compound our income as we did with Microsoft (NASDAQ:MSFT) on Tuesday.
We are still holding two outright bearish positions while we wait to see if the bearish divergence that has emerged on the stochastic indicator is completed and stocks drop again. We are particularly concerned about this divergence as it is occurring at the 61.8% retracement level on the index.
Daily Chart of the S&P 500 (SPX) with Stochastic Indicator
Most risk indicators are neutral, or at least less positive than the S&P 500 right now. We can use bond yields and gold prices as examples of a larger divergence between most other asset classes and stocks and energy.
As you can see in the following chart of the 10-Year Treasury Note Yield Index (TNX), the index has continued to trend flat with only a slight uptick this morning. That trend concerns us.
Daily Chart of the CBOE 10-Year Treasury Note Yield Index (TNX)
This is better than dropping further or inverting again, but it is very rare for stocks to sustain a rally when bond traders aren’t also pushing yields higher.
Gold and the dollar continue to rise in value as well. When investors are still unconvinced that a rally will drive prices higher, we can think about these two assets as “safe havens.” An expensive dollar reduces the attractiveness of U.S. exports, which could damage one of the bright spots in the market right now — companies with more international than domestic business.
When investors are bullish, it’s atypical for gold to rise when the dollar is rising or trending flat. Gold is a non-yielding asset, so investors use it as a hedge or source of portfolio diversification when they are stressed.
It is not a coincidence that gold prices started to rise in 2016 as market volatility began to increase. If gold prices start declining again in the near term, it would likely be a sign that it’s time for more bullish exposure in the portfolio.
Daily Chart of Gold and the U.S. Dollar
With more than half the companies in the S&P 500 reporting, there won’t be much more to learn over the next few weeks from earnings. The market’s technical indicators are a mix of neutral to negative.
This isn’t the worst-case scenario, but it still creates a somewhat cloudy picture of investor sentiment. In the short term, the information most likely to provide some guidance will be employment.
The new unemployment claims numbers for the week are staggering. While we usually disregard this weekly report as too noisy to be useful, it has the potential to affect sentiment if the numbers are much larger than expected.
3.2 million more new claims have piled up. Today’s numbers are also important because the Bureau of Labor Statistics will also release its Employment Situation report for the month of April. According to Bloomberg, the average analyst estimate for that report is for 21 million jobs to be lost in April.
As dramatic as that sounds, the data is already priced into the market. The hazard here is if the numbers come in much worse than expected. If that is the case, retail and financial stocks could drop off fairly hard.
As you can see in the following chart, financial stocks have only retraced 38% of their losses while the S&P 500 reached 61.8%. A disappointment would likely lead to extensive losses in regional banks, brokers, and insurers.
Daily Chart of the Financial Select Sector SPDR Fund (XLF)
The Bottom Line on the Stock Market Here
The earnings picture looks like we will see the worst quarterly growth rates over the last 10 years, but some sectors have still done better than expected. Technology, consumer staples, and health care could continue to be attractive investment opportunities in the short-term.
Without any potential game-changers on the earnings front over the next few weeks, the most important data will likely be U.S. employment. Investors already know the reported job losses will be catastrophic, but as long as the actual numbers don’t exceed expectations, we expect to see the market remain relatively stable.
In our view, that means that even if the bullish trend is getting a little “toppy,” the downside is likely limited, which can still be a very productive situation for option sellers.
John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it. John & Wade do not own the aforementioned securities.