Stocks: Overdue for a Correction?
Despite what appeared to be failed breakouts by the major indexes over the last couple of weeks, the S&P 500 rebounded to a new recovery high last week while the Dow Jones Industrials, Dow Jones Transports, S&P MidCap 400, S&P SmallCap 600 and the Russell 2000 all surged to all-time highs. Bond yields backed off from their recent highs and crude oil prices rose sharply for the second straight week.
The S&P 500 rose 1.01% in January, making it the eighth straight monthly increase for the index, a rare feat indeed. During the last eight months, the S&P 500 has advanced 13.24%, which is actually not that spectacular when we look at the best 8-month price rate-of-changes over history. There were many periods where the index rose over 15% in an 8-month period. However, it is rare to get this many months in a row of positive returns without a loss.
Going all the way back to 1970, the S&P 500 has only risen at least eight straight months on four other occasions. During one of those streaks, the index rose for nine straight months. This occurred from August 1982 until April 1983. The three other periods where the "500" rose eight consecutive months were from April 1980 until November 1980, December 1994 until July 1995, and November 1995 until June 1996. Interestingly, three of these streaks (including the present one) started just as the 4-year year cycle low was put in. Those took place in 1982 and 1994, and were an excellent time to be in the stock market from a long-term perspective. For the latest streak, monthly returns ranged from 0.01% to 3.1%, indicating a consistent increase in the index.
The key to all this is that the return for the market following these streaks has not been great. We will note that there are not enough observations to make this statistically significant and it is certainly possible, but not probable, that the current streak extends to nine months. The streak in 1980 was followed by two negative monthly returns of -3.39% and -4.57%.
During the 1995 run, the market fell 0.03% the first month, then rose 4.01%, and then fell 0.5%. At the end of the 1996 advance, the "500" fell 4.58%, but then rallied 1.88% and then tacked on another 5.4% the third month. During the 9-month advance in '82 and '83, the market fell 1.23% the first month, then rose 3.5% the second month before falling 3.3% the third month. Nothing dramatic was seen on the downside but enough for some investors to step aside.
Also, remember that monthly returns can mask a lot of the volatility that can occur on an intra-month basis. For instance, a monthly loss of 3.5% may have looked like a 7% loss during the month.
While many of the indexes highlighted above have moved to new highs (recovery or all-time), the Nasdaq remains stuck in a base. What's interesting is that while the index has basically moved sideways since mid-November, there was a heavy rush of volume that traded on the index in January but was unable to push the Nasdaq either up or down. January, 2007, was the eighth heaviest traded month in Nasdaq history. Trading volume during the twenty days in January averaged 2.34 billion shares. January's volume was the heaviest since March and May 2006, right before and during the latest correction on the Nasdaq. The index peaked in April, a little before most of the other indexes topped out.
This surge in volume has pushed the 3-week Nasdaq/NYSE volume ratio to its highest level since January, 2004. The three-week average of this volume ratio is up to 153%, indicating a surge of volume into the Nasdaq relative to the NYSE. The indicator is very close to the peak in 2004, which was 158%. The January, 2004, peak is still the highest going all the back to the Internet bubble and implosion years of 1999 through 2001. We believe this is a worrisome trend as it indicates a rapid increase in riskier financial assets with higher beta stocks more prevalent on the Nasdaq than on the NYSE.
In addition, we think it is disappointing that with all this volume being traded on the Nasdaq, that the index is not racing higher.
We believe it signifies a period of market churning, often seen at intermediate-term peaks. Churning is basically the inability of a stock or index to go higher during periods of heavy volume. What is happening is during certain high volume days, up volume on the Nasdaq is being equalized by down volume on the index. Institutions, we think, are lightening up their positions during this period of high market activity. By doing this now, they are basically feeding the market stock at high prices without knocking the index down.
We ran a screen to highlight days where volume on the Nasdaq was above its 50-day moving average of 1.9 billion shares and then looked for instances where advancing volume and declining volume were less than 15% apart. We found that there were four instances over the last 13 days that met our criteria and that may have been evidence of churning. For instance, on February 1, total volume was 2.1 billion with up volume and down volume only 7% apart. The other three days were Jan. 16, 23, and 26. These were all days of higher than average volume and the difference between up and down volume was 12% or less. While churning can occur at anytime, it is more prevalent after an extended move higher.
Treasury bond yields fell last week, marking the first decline since the week of Jan. 5. Last week's pullback is all part of a stair-step advance for yields that started in early December. Last week, we ran into short-term resistance right around the 4.8% area, and in the process, alleviated some fairly overbought readings on the 6-day and 14-day relative strength index. This, in our opinion, sets interest rates up for a move higher to the next area of chart support between 5% and 5.25%. Weekly momentum indicators are not close to overbought levels, giving more room for yields to move higher, in our view.
Crude oil prices surged another $3.60 per barrel or 6.5% last week and now are up an incredible 17% since Jan. 18 or just 12 trade days ago. It's deja vu in reverse for crude oil after the quick pummeling in early January when prices fell 17% in just 11 trade days. Sometimes when markets fall quickly below a support level, there is no resistance when the market reverses because there was little buying on the way down. Basically, there is an absence of supply to slow the advance.
There was very little chart resistance between $50 and $56.50, however, prices have now moved into a zone of potential supply or resistance that runs from $56.50 up to $64. In addition, trendline resistance off the peaks in August and December sits up near $60. While prices could continue a bit higher in the near term, we still expect to see some basing action and some type of reversal formation. Despite the big gains so far, crude oil is still in a downtrend as it has not broken out of the pattern of lower highs and lower lows.