For us, the big question going into the weekend was whether or not the most recent leg higher in U.S. stocks is the beginning of something bigger, a breakout of epic proportions, or just a major whipsaw that will lead to further selling into September and October, two of the most historically volatile months of the year.
We see various crowds. On one hand, you have the bearish cult who for many reasons have fought this uptrend the whole time. Whether they just missed the last couple of years in stocks or, worse in some cases, missed the entire decade, they've been very wrong. There's even a group that wishes harm on the United States and elsewhere around the world, just because they disagree with decisions being made in D.C. They certainly don't want stocks to rise. And then you have another group, which is indifferent and is just looking for a favorable risk vs. reward shorting opportunity, and they think this is finally it.
We have been in the camp, consistently, that stocks are in an uptrend and that we've wanted to be buying them. As we gather new data every day and every week, we re-evaluate that stance to see if there is enough evidence that would suggest that a seller's approach would be more favorable than the aggressive buying strategies that we've been incorporating. The buying has specifically been in individual stocks because, how I learned it, "If you trade the averages, you get average returns." However, the fact that we've wanted to err on the bullish side is in part because we've believed that the major indexes would rise as well.
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Is it true that the S&P 500 is flirting with failing to hold above the January highs? Yes. Is the Dow Jones Composite Average, which combines the Dow Jones Industrial Average, Dow Jones Transportation Average and Dow Jones Utility Average, running into the same dilemma? Yes. One thing I think is worth pointing out, however, is that this is a market of stocks. I've ripped through thousands of charts this weekend, in between football games, and my conclusion is simply this: there are more stocks that I want to be buying than stocks I want to be selling. And this is by an overwhelming amount. It's not even close.
So when it comes to having to decide in which direction we would rather err, the evidence continues to point to an environment where stocks are being accumulated, breadth is expanding and sector rotation rules.
Here is the S&P 500 attempting to hold above this breakout from an eight-month base. If we are above 2,870, then we want to be buying stocks very aggressively. From a risk management standpoint, a more neutral approach in the short term is certainly warranted if we're below it:
Here is the Dow Jones Composite Average. Our big level has been 8,600, which represents the 261.8% extension of the 2014-2016 decline. If we are below that level, then like the S&P 500, a more neutral approach makes sense. But if we're above those January highs, then very aggressively buying stocks is the best strategy by our work:
Finally, the small caps and mid caps have been the leaders. As bulls, we want to see that remain the case. So if we're below $170 in the iShares Russell 2000 ETF (IWM), a more neutral approach is best. But above that and we want to remain aggressive from the long side:
Technology represents about 25% of the entire S&P 500. I would argue that this makes it an important sector for the overall market. Underneath the surface, there are a few key levels I want to make sure we identify. From an upside confirmation perspective, the First Trust Dow Jones Internet ETF (FDN) holding above $148 would be incredibly constructive for the sector, as this has been one of the leaders along the way:
From a risk management standpoint, the iShares North American Tech-Software ETF (IGV) holding above $188 is a key level. If we're below that, then in all likelihood something is wrong and a more neutral short-term approach toward equities is probably best:
We can make the same argument about the First Trust ISE Cloud Computing Index Fund ETF (SKYY) and $55. Holding above that level is key. We want to be aggressively buying stocks if FDN, IGV and SKYY are above their respective lines in the sand:
On another positive note, Berkshire Hathaway Inc. (BRK.B) went up in price every single day last week. This is the largest component of the S&P Financials Sector Index, with an even higher weighting than JPMorgan Chase & Co. (JPM). In our work, we treat BRK.B as another index, like the S&P 500 or Nasdaq Composite.
If we're above $200 in BRK.B, this is further evidence to me that we need to be aggressive from the long side. More specifically, not just buying BRK.B, but financials in general, and therefore the rest of the U.S. stock market as a whole.
One thing that has worked for us is to own the leadership. Getting cute and bottom fishing underperforming stocks and sectors has proven to be foolish. While sector rotation is certainly evident (e.g. healthcare now making all-time highs after struggling for a while), buying the stocks that are already going up continues to make the most sense.
I went through thousands and thousands of charts this weekend. I'm not seeing enough evidence to suggest that turning bearish and shorting stocks aggressively here makes much sense.