US equity markets post largest weekly gain of 2018, poised to move higher

My stubborn insistence, outlined in this note over the past month, that U.S. equity markets would ultimately stabilize and snap back from the most recent downtrend in the near term materialized in last week’s trade. The dramatic reversal that emerged last week in U.S. equity trading was broad, posted meaningfully positive advance/decline metrics, and was sponsored by modestly healthy volume expansion. As a result, the current outlook for the stock market has shifted to a confirmed uptrend.

As the S&P 500 chart above illustrates, last week’s reversal appears to have established a double bottom for the index – which is very constructive for the broader market. That said, last week’s rally did leave the S&P 500 just short of clearing its 200 DMA. Additionally, with the 50 DMA descending and close to a cross of the 200 DMA, an element of constructive caution remains. If, as I suspect, we see a meaningful follow through today from last week’s rally, there is a chance the S&P 500 could avoid a death cross (short term trend crossing downwards through longer term trend). I do expect equity markets to move smartly higher in the near term.

The Dow Industrials are in significantly better technical shape this morning. Last week’s reversal on the Dow provided for a double bottom confirmation, a close above its 200 DMA, accelerating volume, and enough room between the 50 DMA and 200 DMA for the index to likely avoid a death cross – if last week’s reversal finds institutional sponsorship, as I suspect it will.

The relative outperformance by the Dow Industrials versus the S&P 500 and Nasdaq Composite, on a technical basis, speaks directly to the rotation that I have outlined in the note since mid-summer. Increasingly, we have witnessed material weakness in the former leaders of the longest running bull market in history. In short, the FAANG stocks and growth stocks more generically speaking, have lost their collective allure as investors have adopted a more defensive posture due to concern over interest rates, trade tension, and fear of our economic cycle being long in the tooth. The NASDAQ Composite chart below further illustrates the point.

Not only has the Nasdaq posted a sloppy double bottom with the second visit to recent lows being lower than the one first set on October 26, the rally that swept across the U.S. equity landscape last week had a significantly less profound impact on it. The week closed out with the Nasdaq Composite having posted a death cross, closing below its 50 DMA and 200 DMA – all as volume slumped. This chart is yet one more data point that speaks to the rotation out of recent leadership (FAANG). The Nasdaq Composite closed out the week, after the most significant weekly gain of 2018 – still technically mired in correction (-10%) – while the S&P 500 are -6% and -5% off their respective all-time highs.

The drag on performance, provided by the Nasdaq Composite, is likely to remain a headwind for the broader market. However, the rotation that has continued to fuel the Dow Industrials and S&P 500 outperformance will act to provide greater overall market stability in coming weeks and a continued positive bias to trading as we head into the last month of Q4 and 2018.

2 out of 3 near term risks mitigated (Interest Rates & Trade)

Two of the three variables that we covered in November that have been weighing on equity markets have been addressed over the past week. From last week’s note:

“Any indication that the FOMC was considering a pause in tightening could potentially trigger a relief rally for equities.”

The reversal that defined last week’s trading was constructive, but relatively tepid until Wednesday. On Wednesday Fed Chair Powell delivered ignition for the follow through trade higher which pushed the Dow industrials 618 points higher – the most significant one-day point gain in eight months. It was in effect a relief rally. In his address on Wednesday before the Economic Club of New York, Powell indicated that the Fed considers interest rates to be near neutral. In layman’s terms, the urgency with which he has framed tightening monetary policy in recent quarters seems to have shifted to something less aggressive.

That shift by the Fed effectively and immediately tempered the risk that many on the street saw in rising rates – a threat that many saw as primary to derailing our economic expansion.

From the prevue of trade, all three members of the NAFTA accord signed off on the USMCA accord – effectively NAFTA’s replacement. Congressional approval is needed. Additionally, and potentially significantly more important in terms of global trade, Presidents Trump and Xi have agreed to a truce – not to impose further tariffs from January.

That leaves corporate earnings as the variable most likely to weigh on equity market performance in coming months. However, with trade and interest rates addressed – at least nominally for the time being – odds are high that perception of pressure on earnings and guidance may well lighten up.

I continue to remain constructive.

This week’s economic landscape:

This week’s trading landscape will once again be dominated, at least from the perspective of traders, by Fed Chair Jerome Powell, who is scheduled to give a talk on Wednesday at 12:00 pm noon. From a pure economic data perspective, there are several important releases on tap. On Monday we receive the ISM Mfg. Index reading for November. Econoday consensus is 57.2, and October’s reading was 57.7. Other than Jerome Powell’s talk on Wednesday, the EIA Petroleum Status Report is due out that day. Last week the report posted an inventory build for the previous week of 3.6M bbl (gasoline -0.8M bbl and distillates 2.6M bbl.). Additional build in inventory in this week’s report would go a long way in adding some much-needed support to crude pricing, particularly as OPEC is expected to announce an extension of production curbs on Thursday. On Thursday we receive international trade data and weekly jobless claim figures. Arguably, the most critical data of the week comes on Friday morning at 8:30 am. The monthly employment report is due out. Last month saw a jump of non-farm payrolls to 250K – well above consensus. Econoday consensus is calling for a gain of 190K in November. The unemployment rate is expected to remain at cycle lows – 3.7%.

Earnings to watch out for this week:

Tomorrow we receive quarterly results from AutoZone (AZO), and Dollar General (DG). On Wednesday we hear from Lululemon (LULU) and Five Below (FIVE). On Friday we here from Ulta Beauty (ULTA).

Photo Credit:  Paris “Yellow Vest” Riots- The Atlantic Lucas Barioulet / AFP / Getty

Kenny’s Commentary subscribers receive the note in their inbox Monday’s before the US markets open plus media and Sam Stovall’s analysis Subscribe