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The Week Ahead: Too Many Stocks & Too Much Holiday Cheer?

Posted by on Dec 24, 2016

The Week Ahead: Too Many Stocks & Too Much Holiday Cheer?

The stock market was quiet ahead of the Christmas holiday which is not surprising as many investors and traders started their holiday early.  For the 2nd week in a row the Spyder Trust (SPY) has formed a doji which is a sign of indecision.

Clearly the enthusiasm over the Trump rally has waned over the past two weeks and the number of bearish articles has picked up. The concerns over the market’s health have again focused on the arguments that stocks are too expensive, sentiment is too bullish and the bull market is too old.

It is not surprising that some are starting to acknowledge some potholes on the yellow brick road. It seems as though some of the proposed cabinet members are behind schedule in the vetting process. Many believe that uncertainty has limited the economic recovery over the past few years so talk about increasing the nuclear arsenal and heightening tensions with China are not reassuring.

The better than expected 3.5% reading on 3rd quarter GDP did not give stocks much of a boost but the continued improvement fits in nicely with the bullish post-election scenario. Most economists are not that convinced as the Wall Street Journal’s survey of economists is looking for an average GDP growth of 2.2% in 2017 and 2.3% in 2018. They are looking for inflation to run at 2.2% and then 2.4% in  2018 with only a 19% chance of a recession.

The most popular reason that some feel stocks can’t go higher is based on the P/E ratio. Of course the debate on which P/E ratio is more accurate has not slowed down since October when I featured this chart comparing the views of Robert Shiller and Jeremy Siegel.

The post-election rally has triggered another dire warning from Nobel prize winner Shiller who warns that valuations are now near levels seen just before the 1929 crash.

As a market technician I do not focus on the P/E or other fundamental data as long as the bull market is still intact. The P/E worries will be right at some point but I believe the technical studies will warn of a bear market well ahead of the P/E ratios as they did in 2000 and 2007.

I do pay attention to the P/E of the key sectors and industry groups as those that are perceived to be cheap often have the best gains once the technical indicators give the signal. In my October 22nd column ” Market Insights From Past Election Years” I pointed out that for the Dow Jones Financial Sector ($DJUSFN)  ” The weekly relative performance broke its downtrend (line d) in August and then pulled back to its WMA. The way the RS line has turned up from its WMA consistent with a market leader.”

The updated chart illustrates the close on October 21st (line 1) as $DJUSFN dropped to a low of 436.78 just before the election  and closed on Friday at 507.43 as it is up over 16% from the low.  The DJUSFN has been testing its weekly starc+ band for much of the past six weeks so a pulback would not be surprising. The completion of its long term trading range has major upside targets in the 540-560 area which is 10% above current levels.

In last week’s in-depth report on S&P 500 Sectors & Industries Forward P/Es from Yardeni Research has the following forward P/E for the S&P 500 sectors. Three sectors stand out with forward P/E well below the 17.2 forward P/E of the S&P 500. The financials, health care and telecommunication sector have P/E’s that range from 13.7 to 14.4.

In the report they also provide the forward P/E ratios of the industry groups that make up each of these sectors. Those with the lowest P/E include life and health insurance (10.4), diversified financial services (10), biotechnology (11.8) and health care facilities (10.9).

These industry groups are more likely to be some of the favorites of money managers and funds as they look for bargains the New Year.

Though the health care sector still looks negative basis the weekly technical studies it has reached strong support. Some of these lower P/E industry groups may turn positive before their underlying sectors. These are likely to be some good buy candidates for Viper ETF clients.

The Economy

Last week’s data on Existing Home and New Home Sales suggests a positive 1st quarter for the homebuilders.  New Home Sales were up 5.2% while Existing Home Sales also beat expectations.

Despite the strong GDP report, Durable Goods were down 4.6% and the Chicago Fed National Activity Index came in weaker than expected. The Leading Indicators were unchanged in November  which is not yet indicating strong growth in the first half of 2017.

On Friday Consumer Sentiment came in strong at 98.2 which was a bit better than the consensus estimate. The Consumer Confidence is out on Tuesday and the long-term chart shows a clear uptrend.   Retail Sales are still holding in positive territory but it needs to move through the long term resistance at line a, to signal a major breakout.

Also on Tuesday we get the S&P Corelogic Case-Shiller Housing Price Index, the Richmond Fed Manufacturing Index and Dallas Fed Manufacturing Survey. On Wednesday we have the Pending Home Sales followed on Friday by the Chicago PMI.

Market Wrap

The Dow Industrials failed to surpass the widely watched 20,000 area though it did have an intra-day high at 19,987 on Tuesday. All of the major averages were higher led by a 054% gain in the small cap Russell 2000 and 0.46% gains in the Dow Industrials and Utilities. The S&P 500 was up 0.25% and advancing stocks led the decliners 1815 to 1289.  On Friday the volume was the lowest since the 2014 holiday.

The seasonal trend does favor higher prices next week as the S&P has gained over 1% during the last five days of the year since 1928. The NYSE Composite formed a doji last week and it is still below the resistance from the 2015 high, line a.

The NYSE A/D line broke through its resistance, line b, a few weeks ago which is a bullish sign. It does favor an eventual breakout above the 2015 highs. The weekly A/D line is holding above its WMA which is rising. The daily NYSE A/D line made a new high last week as it was stronger than prices.

The daily chart of the Spyder Trust (SPY) shows a short-term consolidation pattern that could be setting the stage for another push to the upside before the end of the year. The daily starc+ band is at $228.66 with monthly pivot resistance at $230.31.

The rising 20 day EMA is at $224 and there is a band of much stronger resistance, line a, in the $218-$220.50 area. The daily S&P 500 A/D also shows a short term trading range and if the rising 20 day EMA is violated there is stronger support at line c.

The Nasdaq 100 and Russell 2000 A/D lines are still acting positive as they are well above their rising WMAs.

What to do?   The technical readings and strong seasonal tendencies allow for another push to the upside as we head into the New Year. This could push the Spyder Trust (SPY) 2-3% higher and move the Dow Industrials well above the 20,000 level.

If the stock market does move to further new highs then it is likely more vulnerable as we start off the New Year. Many investors have likely held off selling because they hope for more favorable tax treatment in 2017. Also they may realize that they spent too much over the holidays and may have too many stocks.

Should the SPY reach the $230 level a drop back to $220-222 would not be surprising which would be a correction of 3-4%. Given the strong signals from the weekly and monthly A/D lines such a correction should be a buying opportunity for both traders and investors.

The recent surge in bullishness has made investors and traders less cautious. Some are buying stocks before they bottom or are holding on to stocks after they have topped out.  Not all stocks go up even in a strong market.

For example new short positions in MarketAxess Holdings (MKTX) at $162.26 were recommended in last Monday’s Viper Hot Stocks Report . This was based on the prior week’s close and doji sell signal along with the negative readings from the relative performance analysis. It closed down 8% for the week and after an oversold bounce it can still go lower.

This illustrates the importance of doing a careful technical review of any stock or ETF before you take a position. Once the market does correct or consolidate investors who are looking at the intermediate term should favor well-diversified ETFs that have a low expense ratios.