Research.LeutholdGroup

Bulls have been quick to assure us that this market “bears” no resemblance to the dot-com bust. We agree—but probably for very different reasons. Among them are the conventional breadth measures, which provided little warning of this year’s January peak. And, the initial decline off January’s top has been much broader than during the first phase of the dot-com bust.

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In late March, the S&P 500 rallied to within 3.5% of its January high, likely prompting producers at CNBC to put in an order for “S&P 500 5,000” hats. But we think that 4,000 will be undercut before 5,000 is topped, and action in key indexes (with the notable exception of the S&P 500 itself) reinforces our view.

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Technical types who have the luxury of avoiding the worsening valuation, inflation, and liquidity backdrop probably view today’s market as a much “safer” one than has existed for many months, now that breadth and leadership cracks have been mostly sealed up. 

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The MTI’s move to its Negative zone with the October 1st reading was driven by a few trend breakdowns—ones that could well reverse in short order. Recognizing the volatility of these signals (and perhaps having been “conditioned” by the one-way market of the last 18 months), we opted for just a minor asset allocation adjustment.

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A new market high that is not confirmed by the stocks of companies that “move the goods” is a warning signal. We reviewed the Transports’ action in all years the S&P 500 accomplished a 12-month high during the month of July, like it did this year.

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There have been long-time divergences between blue chips and other market segments signaling that all is not “in gear” beneath the surface—but this cautionary activity never foretells the “timing.” Recently, Small Caps, the Value Line Arithmetic Composite, and Dow Transports staged pathetic bounces off the January 31st “Coronavirus 1.0” low, while the blue chips had strong momentum into mid-February. Normally, such divergences typically last for at least 3-4 months before they become meaningful.

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After last year’s 30% S&P 500 gain, many strategists are now suggesting that the real melt-up still lies ahead. We think a melt-up has already occurred, and the bulk of it has been booked.

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We noted that the December 2018 stock market low was the second most expensive in history, second only to that of October 1998. Similarities between 2019 market action and the 1998-99 rebound remain eerie. Something isn’t right, and it’s not bullish.

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The granddaddy of all technical indicators—the NYSE Daily Advance/Decline Line—continues to make new highs alongside the S&P 500, suggesting the market should move to even higher (but perhaps narrower) highs well into the fall. As noted a month ago, we increasingly suspect that granddaddy may be telling a lie.

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Yesterday’s S&P 500 new all-time high triggered a few simple internal studies we’ve used to help shape second-half expectations for the stock market.

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We think the current economic cycle is more likely to end in a deflationary bust than with a bout of late-cycle “overheating,” and analysts and investors should recognize that such a cycle ending could be especially difficult to detect.

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Leadership, breadth, and corporate credit all staged intermediate-term breakouts, rising above their respective 40-week moving averages. In this formation, historically, S&P 500 annualized return is +15%.

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While our MTI became bullish in mid-April, we can’t rule out that the rebound from February lows could be an impressive bear market rally. However, this rally sports impressive technical credentials.

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Remember that peaks in market breadth tend to lead peaks in the S&P 500 by at least a few months.

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While stock market action YTD has not been quite as “uniform,” the hallmarks of an imminent bull market top are simply not present. The bullish portents apply to intermediate term results, however, they cannot rule out any short-term setbacks (which can appear with no tip-off from breadth or leadership measures).

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