The S&P 500 gained 1.76% this week with Friday's close at 3,185.04.
The index has now increased two consecutive weeks for the first time since the end of May. We started the week recovering all of the prior Friday's decline, trading up to 3,182.59, before closing at 3,179.72. The "ghost" (i.e., resistance) at the ~3,150 region we discussed last week then did its best Tuesday through Thursday to slow the week's advance. Thursday's low at 3,115.70 left the index in negative territory for the week, and marked a -2.10% decline from Monday's high. It felt as if the "ghost" would prevail once again, but as is always the case in Scooby Doo, Shaggy and Scooby saved the day.
The S&P 500 would gain 2.22% from Thursday's low into Friday's close, and left the week's price action best described as "accumulation". The index traded down to 3,136.53, 3,115.70, and 3,136.22 each of the last three trading days - yet all three trading days closed more than 1% above their respective daily lows.
From our lenses, this week looked like a good bit more of "eager buying interest into lower prices", a hallmark of uptrends.
The chart picture remains constructive, for now. The index is unchanged the last ~21 trading days, consolidating mostly between ~3,150 and ~3,000. Given the remarkable upside rally that preceded the prior ~21 trading days, trading sideways over the last month is the epitome of "winning by not losing". The S&P 500 has been on the ropes multiple times since June where a true "bear market" would and should have landed a barrage of punches, analogous to the S&P 500's decline accelerating to the downside. Instead, the S&P 500 fought its way off the ropes every time, taking virtually no damage, and has then landed its own barrage of punches. The most recent example is the upside pivot off this past Thursday's low.
While the index didn't "break out" this week, it is now in position to do so over the week ahead. From our perspective, we believe the index will retest the ~3,233.13 level sooner rather than later. Using weekly closing prices, a weekly close above 3,193.93 would mark a recovery high, and hurdling 3,225.52 would essentially place a bullseye at 3,380.16. From a momentum perspective, at least on the weekly time frame, there isn't an "overbought" reading in sight - there's plenty of room to run to the upside.
Now, we know what you're thinking:
"But Steve and Rick, how can the S&P 500 possibly continue to rise given all of the uncertainty surrounding the coronavirus, the economy, the election, and the future earnings of the S&P 500?"
It's a great question, and there's an easy answer:
The price of the S&P 500 trades beyond the limits of imagination.
To be clear, nobody truly knows why the price of the S&P 500 does what it does. But it's irrational to expect the price action of the S&P 500 to be rational.
It's not supposed to make sense. If the price action of the S&P 500 was rational, logical, and sensible, it would be predictable...and we'd all make a lot more money investing.
Instead, the price action of the S&P 500 is irrational, illogical, and it makes no sense, no matter whether we're talking about the price action in the early 1980s or year-to-date in 2020, and therefore it's entirely unpredictable. This is the norm, and scratching our heads over the price action of the S&P 500 is the baseline expectation. This is why investing is hard, it's why there's meaningful risk, and it's why there's meaningful reward over time.
It's also why we are so passionate about investing systematically, or using rules to make investment decisions.
We could never imagine making discretionary investment decisions into a climate like we've seen in 2020, as we'd want to be allocating portfolios with 100% cash and fixed income at the moment (we're risk averse guys). Heck, based on discretionary decision-making, we would probably have been holding nothing but cash since late 2018's crash as the upside we've seen since hasn't made any sense either.
Part of why it's easy to believe the S&P 500's upside since March makes absolutely no sense lies in the fact that the bearish narrative deals with what's known and knowable. The bearish case, or the best-case explanation of why stock prices should head to the south deals in facts. Everyone, and I mean everyone, realizes the predicament we're in facing the coronavirus, the economy, the election, and corporate earnings. It's easy to feel like "we're doomed".
It's not easy to believe that "we're not doomed", it's not easy to have faith in the future being materially better than the present.
The bullish case always deals with what is unknown and unknowable. Explaining why stocks should head to the north over the remainder of 2020 deals with pure speculation and putting a positive spin on the future variables affecting stock prices the remainder of the year. That's always easier said than done, since generally speaking, our brains just aren't wired that way.
As humans, it's incredibly challenging to put faith over fear when facing a storm of negativity. When bad things happen to us, it's not easy to find conviction in the idea that everything is going to be fine. This is what the investment community is struggling with at the present moment, ourselves included, since bad things have happened to us (think March 2020) and we're facing a storm of negativity. But the message the S&P 500 is sending us right now is that everything's going to be fine, no matter how hard it is to believe.
Now, this does not guarantee that the S&P 500's message in the present is going to be correct about the future...we may very well be "doomed". It just might take us all believing we're not going to be "doomed" before we actually face our doom - remember, it's not supposed to make sense.
Finally, while 2020 has been totally crazy, and it's easy to think that modern markets are completely and totally different than the past (i.e., increased volatility, larger price swings, etc.) that's just not the case. The chart below is the price action from 1980 through 1982, the equivalent of the Stone Age when comparing the way participants transact to 2020. Yet even 40 years ago the S&P 500 was as volatile as it gets, falling -18.72% from a February peak into a March bottom, then climbing 45.27% from March's low into November's high, only to then decline -28.5% from November of 1980 to August of 1982, to finish it all off with a 44.99% rally from August to December of 1982. If we were preparing our Update in that time period, I imagine we'd be writing about how the price action of the S&P 500 doesn't make any sense. About forty years later, and it still doesn't make any sense, at least not until we have the luxury of hindsight.
S&P 500 Primary Trend - Neutral, For Now
The S&P 500 is not only in position to break out on the weekly chart, it's also in position to break out on the monthly chart, too. Our all-time high monthly close stands at 3,230.78, a mere 1.43% above Friday's close.
The month of June had the same opportunity to close at an all-time high, yet there was meaningful selling pressure shortly after trading up to the ~3,230 price region. The month of July now has the same opportunity as June, so to say the price action the coming 15 days is pivotal is an understatement.
As of today, the primary trend for the S&P 500 is labeled as "neutral" or trendless. However, an all-time high monthly close, preferably one above the 3,300 level, will solidify the primary trend as up or "bullish". From a chart or price action perspective, it will appear as the S&P 500 finally breaking out of traffic. It will put the index in position to slam on the gas and finally get moving to the north.
The market's best player, the technology sector, has already broken out to the north. The S&P 500 Information Technology Sector Index is slamming on the gas as we speak.
The S&P 500 Consumer Discretionary Sector (SPCC) is also slamming on the gas. SPCC is higher by 7.09% thus far in July, with its largest single component, Amazon (AMZN) rising by 15.99% thus far in July (keep in mind July is only 7 trading days in).
So, while the primary trend of the present is labeled as "neutral", the most likely primary trend into the future is "up".
As we wrote last week, it's imperative long-term investors don't let the fear of striking out keep them from playing the game. In the event the primary trend for the S&P 500 moves from "neutral" to "up" here in July, long-term investors will be best served implementing their target allocation toward stocks or equities within their asset allocation...no matter how uncomfortable it may feel.
Two Pink Flags: Equal-Weight Continues to Lag, Some Stocks Bubble- Like
While the tone of this week's Update is predominantly "bullish", there are two pink flags (not quite yet red) we can observe that help to keep us humble about any upside conviction into the future.
First, the S&P 500 Equal Weighted Index (SPXEW) continues to lag behind the traditional market capitalization weighted S&P 500 Index (SPX).
These two indexes are comprised of the exact same stocks, but simply allocate to these stocks in different percentages. SPXEW gives an equal weight to all constituents, meaning the price of the index is influenced equally by all constituents. SPX allocates based on the size of the stocks held within the index (i.e., the largest market capitalization stocks have the highest weighting in the index and the smallest have the smallest).
A disparity in performance across SPX and SPXEW is considered a form of "divergence". What we're witnessing today is SPX rising at a much faster pace than SPXEW, which suggests the largest of stocks are increasing at a rate greater than the majority of constituents. If you're only as strong as your weakest link(s), then there's a lot of weak links on this team.
SPXEW declined -0.22% this week while SPX gained 1.76%. In fact, the weekly chart of SPXEW relative to SPX has now decreased 5 weeks in a row and SPXEW has lagged SPX by -7.13% over the trailing 5 weeks, a degree of short-term underpeformance we've rarely ever seen for SPXEW. The ratio sits almost exactly on its 2020 year-to-date lows. A "double bottom" possibility comes to mind and would certainly help to alleviate SPXEW concerns.
When digging into the sector allocations of SPXEW relative to SPX, the biggest deltas are in the following sectors:
Information technology: +13% allocation in SPX
Communication services:+6% in SPX
Industrials: +7% in SPXEW
From a sector composition standpoint, it's no wonder SPXEW can't keep up with SPX. SPX is overweight technology - technology is the Lebron James of the market - and technology's cousin, the communication services sector, whose largest holdings just so happen to be Facebook, Google, and Netflix. Both of these areas are absolutely killing it, while SPXEW is overweight industrials, financials, energy, utilities, and materials, and none of these areas are killing it.
However, the market can't be a one trick pony forever. It can't just be the technology show...that's not going to be lasting. Momentum in the ratio of SPXEW compared to SPX, defined by weekly RSI(14) closing the week below 30, has been rather prescient at suggesting when SPXEW's lag is a problem, and while we're getting close, we're not there yet (weekly RSI(14) closed Friday at 38.29).
That said, this will remain a pink flag until SPXEW can join SPX at the party. From a contrarian perspective, it's easy to believe this is coming sooner rather than later. The financials did at least come alive this week, recording a bullish outside reversal week and rising by 2.15%. We have bank earnings on deck for the week ahead, so it will be interesting to see if the financials can rise for a third consecutive week and perhaps help SPXEW outperform SPX for the first time in six weeks. To have confidence in the S&P 500's uptrend continuing, we'd like to see "rotation" into sectors other than technology.
The second pink flag is just the bubble-like price action we're seeing in certain names. Amazon (AMZN), for example, has increased 10 consecutive weeks and 16 of the last 17 overall. The stock has gained ~42% the last 10 weeks and ~97% the last 17 weeks.
While AMZN fundamentals are absolutely incredible, they're not this incredible. AMZN's forward P/E ratio is well north of 100, not that valuations actually seem to matter here in 2020.
Tesla (TSLA) is a similar story. TSLA gained 27.80% this week and has climbed 341% since March's low at $350.51 (not a typo). While TSLA produces a fantastic product, they don't produce this fantastic of a product.
This type of price action in AMZN and TSLA is alarming, especially in AMZN's case where it's the 3rd largest holding in the S&P 500.
Parabolic advances never end well, incredible returns in the present always have to be paid back into the future, and the more stocks we see trading like this (from penny stocks, to wanna-be electric car manufacturers like Nikola), the more we buy into the idea that we're witnessing a liquidity-induced bubble. Again, we're not there yet, but we're on that path when we see AMZN and TSLA trade the way they're trading.
So, these are two areas that serve to add to the "wall of worry", as if we needed any more. We'd feel better if SPXEW would get its act together and if AMZN and TSLA would stop rising at a near 90-degree angle. We don't think that's too much to ask.
Happy Sunday!
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