Weekend Update: Yet Again, Another Strong Jobs Report

Yesterday's trading session showed a positive response to another increase in non-farms payroll. Not only was the June report better than expected but both April and May's payrolls were revised higher. The continuing improvement in the labor market has made markets nervous recently due to the likelihood of a reduced easing policy from the Federal Reserve; it appears to me that the market is on its way to pricing in the effect of a QE reduction. It would seem to make sense that an actual improving economy would trump easy money policy and low interest rates, but as we discussed the other day, the market rarely behaves in a logical way; if you approach the market logically, you will likely end up very frustrated and in the red. This is why we don't press our personal views onto the market, the market simply doesn't care.

 So what are we to do then? If we can't approach it logically does that mean chaos and irrationality reign? Well, some yes and some no. We can't ever have a uncompromising bias on market direction, but we also can't just throw darts and hope randomness prevails for us in the end. We need to make calculated decisions that are based in fact and need proper risk management techniques in place in case our ideas are wrong.     Simply, we need to listen to what the market is telling us, about what groups should work in a "reduced" QE state and what groups will not.

What's interesting in this market recently is that while the averages as a whole have been showing signs of transition, SO many individual names are making new all-time highs or breaking out of consolidations. Usually a sign of a weak market (especially when a uptrend begins to transition) will be a breakdown under the surface in key individual names and sectors. But in this market we are still seeing Financials, Discretionary and Industrials leading the market on up days and holding up better on down days. All the while defensive groups like Utilities, Real Estate Investment trusts, Treasury Bonds, Gold...ALL  of these groups are getting crushed. The market is trying to show us what will work when interest rates begin to rise and free money flow is reduced. It is saying that banks, economic improvements in terms of building and repair, and the consumer will be strong going forward. Its also saying that rising interest rates will force prices down in inflated Treasury Bonds. Gold is showing that uncontrolled inflation and economic crisis will be off the table in the intermediate term future. Over the past decade when markets have struggled, these defensive groups have thrived, until recently when the SP500 was lower, gold and bonds would be higher. Now we are seeing Gold and Bonds being taken to the woodshed whether the market is up or down; they are behaving like underperforming assets...Not up enough when markets are up and down more when markets are down. Both Bonds and Gold have had nice runs over the past decade, but it appears now to be a time of correction. These are the inter-market relationships that we need to watch for. These will be the key hints to how we need to position ourselves in our portfolios. While it is true that all these factors could reverse, for now this is the game-plan we have to deal with.

Lets take a look back at the SP500, Treasury Bonds and Gold showing the relationship of the three recently:

SPX

 The SP500 has found support at its rising 20 WMA and is now testing the short term downtrend resistance. It is still in its well established uptrend from the 2009 lows.

 Treasury Bonds (TLT) 

Treasury bonds have broken down and are now trading well below a declining 20 WMA. Price broke major support in the past month and should likely head lower.

Gold (GLD)

Gold is in the same boat as Treasuries except it has been at its downtrend for a while longer. Still ugly action here.

This is the response of these assets since the "QE" revolution in our financial markets. Gold rallied on fears of economic contagion and rampant inflation. Treasuries rallied on similar fears and unprecedented Federal Reserve Bond purchases. Stocks have been drinking the Kool-Aid too as they have rallied strongly from the crisis lows and the introduction of aggressive QE policy. However the major difference that I am noticing is that while the "taper" or reduction of QE conversation is crushing Bonds and Gold, apparently stocks didn't get the memo. While Bonds and Gold have been breaking down from major support, the SP500 has been breaking out from major resistance.

If this were the start of a meltdown for the market I believe we would see Treasuries and Gold starting to build bases to rally from, as historically they have out performed when stocks have struggled. But we are seeing no, ZERO evidence of a bottom in these assets. These are in full crash mode. Until there is a definite consolidation in these groups I just don't see a lot of value in worrying about the stock market too much at these levels. Short term there is still some work to be done to completely right the ship, but longer term, stocks look like a winner from my view. In fact something that could play out here is that stocks in fact continue to correct through the summer back to the long term trend support. While Bonds and Gold stabilize and rally back a bit as they are heavily oversold. That scenario would then create the opportunity for Stocks to take a breather, then rally on to new highs.

The point I'm trying to make here is that while it would make sense for stocks to correct here a bit, there is really no evidence on the longer term view of them being in any trouble. As defensive groups get crushed and offensive groups make new highs, the thesis for higher prices is still intact longer term. When the defensive groups stabilize and reverse their downtrends we will adjust our positioning as well. But as of now those groups are under performing and in downtrends. Here we buy uptrends and short downtrends. As long as these continue their current course, so will we.