Weekend Update: Safety Trade

To Piggy-back off last week's ideas, despite continued positive economic data and solid earnings reports, markets continue to have trouble following through to the upside. While the major indexes did manage gains this week, the key levels of resistance continue to be met with sellers. We saw a good example of this on Friday; the April Jobs Report was released and it was solidly above consensus estimates. One would expect the market to finally put a breakout together and move above this ceiling in prices. However initial strength was met with caution and all but the Russell 2000 finished negative for the day.

 An important concept to understand is that if an asset fails to trade higher on good news (positive surprises) it often means the market is fairly priced at current levels. After a very strong year in 2013 stocks have struggled to continue to push higher. When you see a company trade lower on a blow-out quarter or the market reverses after strong economic news, it is a big red flag that needs to be taken seriously.

 There are several things holding back new buyers at this point such as Russian tensions, tepid US growth, and poor seasonality. You have heard the saying "sell in May and go away", while it sounds catchy, there is actually a fairly significant historical headwind that faces the stock market from May through October. Take a look at this article for a further explanation of this phenomenon. While we certainly could see continued gains from here, history and the odds favor more difficulty in the months ahead.

When you combine poor seasonality with a market that is not responding to positive news AND previously leading stocks breaking down while defensive groups show relative strength, it is careless to ignore the confluence of warning signs. This doesn't mean go out and build a bomb shelter but it does mean that caution is the correct position to take.

Lets take a look at the major market indexes after this week to recap where we currently stand:


SP500

The SP500 took another shot at the range highs but once again failed to break higher. The fact that the blowout jobs number Friday failed to push the S&P above its resistance levels is notable. This is still the best of the US indexes and it is still holding its uptrend trajectory (for now).

Russell 2000

This is a pattern I am seeing develop in a lot of individual names as well. I am seeing stocks breaking their longer-term Relative and absolute uptrends. While the trend weakens, prices are just consolidating the prior losses below the 20 WMA and below prior support levels. Remember the idea of "polarity" in the market: once a support level is broken it will then act as resistance on a move back higher. What I'm seeing in the Russell 2000 looks to be the early stages of a trend change.

Nasdaq

We continue to see buyers step in at the critical 4,000 level which is a positive, but this level is being tested repeatedly and the more often a level is tested the more likely it is to fail. The previous buyers begin to dry up as each attempt at a rally is met with selling pressure.


Bonds (TLT)

Treasury Bonds took off this week gaining more than 1.5% (which is a big move for bonds especially). We continue to see money flow into safety and what was so surprising about the bond rally this week was Friday's response to the better than expected Jobs data. Typically a strong jobs report means a strengthening economy and therefore higher interest rates (bonds prices lower). But what we saw was a swift reversal just after 7am when bonds had been sold at the open following the strong data. The swift intra-day reversal showed investors are looking for any headline or excuse to pile into safety.

Money was suppose to move to stocks for a "risk on" type rally on a Jobs beat like that. This just again reinforces that no matter what we think should happen the market will always surprise us. It shows how important it is to observe what price is actually doing and not what we expect it to do. If someone told me Thursday night that the Jobs number was going to be 288k vs 210k expected, I would have said sell my bonds and pile into stocks. We don't trade what we think, we trade what we see. And I see a risk averse market where big money is seeking shelter, not risk. Continue to own TLT aggressively above $108. The Double Bottom pattern in play still targets prices roughly 3% higher from here near $115.50.


Looking at our holdings as we enter next week we have two close calls and the rest look solid. Lets look at the holdings that need the most attention first:

UNH

UNH is trading heavy and continues to probe the prior resistance area. This week we did see a violation of the 20 WMA but prices are still just at the edge of the support area. I am willing to give this the benefit of the doubt for a week to see if it can recover quickly. Should it fail to bounce back soon I will step aside and reduce risk further. The RS trend is still in play here and is in a long-term uptrend so we will want to continue to position ourselves toward that long-term strength.

PPG 

PPG has closed below its 1-year trend support but is still holding the long-term RS trend and is above the key support area at $188. Above those levels we want to be in PPG as long-term this is a big winner. We will hold as long as price and trend agree with our risk management principles.


As for our stronger positions that continue to hold up well:

AEP

This is the risk you run when you adjust your plan mid-trade. AEP achieved its base target mid week, but due to the larger breakout that we looked at last week, I chose to let the full position ride instead of trimming into the target. As you can see, once the target was hit the stock sold pretty hard off the best levels. Long-term I love this holding and I want to be part of this larger timeframe breakout in motion, but just know the risk of adjusting your trade plan midstream. This is a rare occurrence for me to deviate from my plan, but in the circumstance we find AEP in long-term, it makes sense to double down here as it were.

CMI

Cummins made a new all-time high this week despite all the noise buzzing around the market place. We want to maintain an aggressive posture here above $140 and still are bullish long-term above ~$125. The RS resistance was also broken solidly this week signaling continued strength going forward. We will need to see prolonged weakness to cloud the picture too much here.

WFC

Wells Fargo is trading in a very clean and defined uptrend. Relative to the market and the Financial sector, WFC continues to outperform. What I really like about this chart is how there are very clear levels as to where the trend will fail. Currently that level is right below the 20 WMA at $46.50; with further strength and consolidation around these highs we could move our stops above $48.


It appears that many stocks are either breaking down or need pullbacks to retest trend supports. We could see 5-10% pullbacks in many leading names and they would simply be retesting their prior breakout levels. Others that are weakening could also see a similar pullback to longer-term support levels. There is no telling how long a move like this could take to play out but an orderly 10% correction through summer would seem to fit with the current look of the markets here. That would be a welcome development as it would let some of the more extended names trade back to retest key levels and also give the weaker stocks time to build proper support bases.

There should be no need to fear a correction as the proper Relative Strength rotation within your accounts should adjust accordingly to the changing environment. If you are 100% long Biotech and Consumer Discretionary stocks then you either are a glutton for punishment or are not listening to what the market is telling you. You are likely dug-in on your "hopes" for where the market will go in the future and not using an objective view of the market. A robust trading method should have you adjusting to the evolving environment and be systematically positioning you to take advantage of what the market gives you.

Don't force it, don't fight it, and don't hope...You will be in a much better position long-term if you keep risk objective and listen to what the market says is the correct path forward.

Chart of the Week

CAT

CAT is an example of a leading stock that could use a 5-10% pullback to retest the breakout level before moving higher from here. That would provide an excellent place to add to current holdings or initiate a new position if you didn't have one currently. I have been Long CAT since ~$90/share so a pullback to $96ish would suit me just fine as it would allow some of the overbought condition to work itself off through summer. There is certainly no rule that says it can't continue higher from here, but a pullback would allow the trend to refresh for another sustainable leg higher.