We had been expecting a pull-back in the stock market after its nice two-week rally, so the decline in the market yesterday was not a surprise. In fact, it can be seen as normal and healthy. Of course, if the pull-back becomes a deep one, it’s going to be a problem, but yesterday’s decline was not anywhere near enough to declare that a powerful decline lies dead ahead. In other words, things are playing out much like we thought it would early this week. We could see some more downside follow-through for a day or two more, but what we really want to see is the action after this short-term “breather.” Therefore, we still believe the action in the market over the next 3-5 trading days is going to be important for the stock market’s action over the next few weeks.
Earning season is getting started in the same way it did last quarter. Several banks reported pretty good numbers yesterday and their stocks opened higher...but then they sold-off for the rest of the day and finished more than 1% lower. This is exactly what happened in July...and it’s disappointing once again...but we have to remember the initial poor action in the bank stocks did not hurt the broad market at all during the rest of the last earnings season.
What we’re saying is that we shouldn’t draw too many conclusions from yesterday’s action in the banks. JPM had rallied 12% over the previous two weeks, so the fact that it pulled back a bit as it was testing its 200 DMA (a key resistance level) is not the end of the world. After such a strong pop over a short period of time, it’s not a big deal that JPM saw a mini “sell the news” reaction.
HOWEVER, like the rest of the market, we’ll be watching to see if JPM and the other banks experience just a short-term “breather”...and then rally further...and break above the resistance levels we touched-on earlier this week. If they can, it’s going to be very bullish for the group. If, however, any “breather” turns into a more prolonged decline, it will confirm that the banks stocks are continue to be dead money for now. Of course, if recent history is any guide, the action in this group going forward is going to depend upon the direction of interest rates and the movement in the yield curve......In other words, we’re still in a “wait and see” mode on several different areas of the market place right now........Luckily, we shouldn’t have to “wait” very long to see which way things will playout.
Yet another asset we’ll continue to keep a VERY close eye on is the currency market. The movement in the dollar since May has been a GREAT contrarian indicator for the stock market (and for gold and other commodities as well). The drop in the dollar in May & early June went along with a further bounce in the stock market off the March lows. Then, a two week bounce in the greenback in the second half of June corresponded to a dip in stocks.
As we moved through the summer months, this (contrarian) relationship remained the same. A steady decline in the DXY dollar index during July and August corresponded very strongly with the nice rally in stocks we saw during those two months. When the dollar bounced in a meaningful way in September, the stock market fell in a significant way. Then...as we moved into this month...the dollar has slid lower again...and sure enough, stocks have rallied. (DXY dollar chart attached below.).....Heck, it was even a great indicator yesterday...as the strong one-day bounce in the greenback corresponded with the first down day in the stock market in five days.
We still believe that the “positioning” in the currency markets (especially the dollar and the euro) will make it very tough for the dollar to fall significantly more (and for the euro to rally significantly more) over the intermediate-term. The net positions in the dollar & euro in the COT data are just too extreme right now in our opinion for that to happen. HOWEVER, that does not mean that they cannot continue on their most recent trends (lower for the dollar, higher for the euro) over the near-term (between now and the election). Therefore, if the dollar can fall further, the stock market can certainly rally further over the coming weeks.
Okay, we’ve highlighted several things to keep an eye on recently. Earlier this week, we said the chip stocks and the small caps would be important. Then we said the banks could also be a catalyst for the next short-term move (along with the bond market). NOW, we’re saying the currency market is yet another asset class to keep an eye on......Well, we all only have two eyes, so which ones should investors be watching the closest? We think the chip stocks and the dollar are the two to follow more closely. The semiconductors have been a GREAT leading indicator for stocks for a very long time...and the dollar has been a tick-for-tick (contra) indicator more recently. Therefore, we’ll be watching these two assets more closely than any others.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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