The mid-session reversal today was a disappointment for traders looking for another day of gains. Trade threats between President Donald Trump, China and Mexico, as well as Brexit, are very difficult issues for investors to integrate into prices in the stock market.
On the bright side, the 10-year Treasury yield failed to confirm a bearish harami I have been watching over the past two days. This short-term signal consists of a large green candle followed by a smaller candle of any color that fits within the "body" of the first candle. If followed by another negative close, a bearish harami is a signal of worsening momentum.
Banking stocks in particular should benefit if yields continue to rally. This would be the perfect time for a rally to occur as the big bank earnings reports are scheduled to kick off earnings season, with JPMorgan Chase & Co. (JPM) on the 12th, Wells Fargo & Company (WFC) on the 14th, and Citigroup Inc. (C) and The Goldman Sachs Group, Inc. (GS) on the 15th. An optimistic outlook from the big banks could give earnings season a needed boost.
The S&P 500 reached a new short-term high today but failed to hold it as investors worried about external risks, including a potential closure of parts of the U.S./Mexico border by the Trump administration. Concerns about trade and a higher-than-expected oil inventory report likely contributed to a decline in energy prices and related stocks.
Similar concerns about trade also hit manufacturers and industrials, which turned in the lowest performance of any sector in the market today. The pressure on industrials and energy kept the S&P 500 within its "rising wedge" formation, which, while not inherently bearish, could portend a short-term drop back toward support near 2,800.
Risk Indicators – Lack of Confirmation
Despite a good run in the S&P 500 over the past few days, market breadth has been a little soft. In this case, that means two things. First, the rally has been driven by a relatively small number of big stocks, and second, there still hasn't been confirmation from small caps or transportation indexes.
The first breadth problem is likely the result of investors feeling more risk averse and favoring larger companies with reliable fundamental trends. However, I wouldn't characterize this as a flight to safety or safe-haven stocks. Among the biggest winners over the past month in the S&P 500 index includes tech companies like NVIDIA Corporation (NVDA), Advanced Micro Devices, Inc. (AMD) and Arista Networks, Inc. (ANET). Consumer retail has also done well, which is a positive sign for economic growth.
Historically speaking, the second issue is a concern but should not be perceived as a signal that the market can't rise higher. When the major large-cap indexes are breaking to new highs, it's not uncommon for them to lead the breakout in transportation and small-cap indexes. However, until those indexes also reach new short-term highs, technicians will consider the market a high-risk environment.
Waiting for confirmation before adding a lot more long-stock exposure is a time-tested strategy for evaluating trend strength dating back to Charles Dow (of Dow Jones fame) and the technical analysis principles of "Dow Theory." As you can imagine, if investor risk appetite is really shifting in favor of stocks, it should drive small caps higher and faster than large caps after the initial breakout.
The lag in small caps has the same implication as the current stagnation in high-yield bonds. Investors in assets outside the major large-cap indexes still appear cautious and could trigger additional selling if the news turns bad. As you can see in the following chart, the Russell 2000 small-cap index is just emerging from a downtrending channel, but it is still stuck below its prior short-term highs.
Bottom Line – Little Market That Could
The Labour Party leader Jeremy Corbyn met with U.K. Prime Minister Theresa May today to begin working through a Brexit compromise while parliament takes a vote to block any "no deal" Brexit outcomes. According to Corbyn, the talks were "constructive," but investors will have to guess what "constructive" actually means. The President of the Bank of England (the U.K.'s counterpart to the U.S. Federal Reserve) was quoted today that the prospect of a "no deal" Brexit is rising and that the consequences of such would be dire.
While we wait for earnings season to kick off, the daily flow of Brexit news will likely outpace even U.S./China trade news as the most important driver of stock prices. As such, investors should be prepared for the potential of more mid-session sharp reversals like we saw today. Confirmation from small-cap indexes and transportation stocks remains unlikely while this level of uncertainty is lurking.
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