Stocks Surged 3.84% This Week. Retesting ATH's Awaits.

The S&P 500 gained 3.84% this week with Friday's close at 3,477.14. Friday's close is the second highest weekly close in the history of the index.

The S&P 500 came out of the gate flying on Monday, gaining 1.80% and climbing all the way back to the 3,400 price region. We found this surprising as we wrote last Sunday that a trip back to the ~3,400 region sooner rather than later was "asking for a bit too much". Apparently, it wasn't asking for enough!

The S&P 500 struggled with the "boogeyman" at the ~3,425 price region on Tuesday. The index traded up to 3,431.56 at the day's highs, only to then trade down to 3,354.54 in under an hour before finishing the session at 3,360.97. The "news" or catalyst to Tuesday's downside reversal was a tweet from you know who. The narrative at Tuesday's close was that "resistance" had held, but the S&P 500 went on to tell a drastically different story the remainder of the week.

The index closed higher Wednesday through Friday, gaining 3.45% in total over the last three trading sessions. The S&P 500 fought through the "boogeyman" and cleared both hurdles we referenced in last week's Update. The stage is now set for a retest of our all-time highs at the ~3,580 price region, and the odds certainly favor September's low at ~3,209 being a lasting bottom for the remainder of 2020.

We can't help but recall what we wrote about the S&P 500 from our Update two weeks ago (click here):

"Recall that we came into the month of September on a five-week winning streak, and we've done nothing but lose here in September. Ironically, we're headed into October on a four-week losing streak and, if history is any guide, it suggests that we'll do a lot of winning in the month of October."

So far, we've done nothing but win in October.

The S&P 500 has gained 3.39% through the first seven trading days of the month, and has increased two weeks in a row, gaining 5.42%. With October being known for some of the biggest market moves in the index's history, we were compelled to research the S&P 500's forward price action after a strong two-week price thrust in the month of October.

Since 1950, there are 11 prior instances where the S&P 500 gained 5% or more over a two-week period that ends in the month of October (this week marks the 12th instance). Interestingly, the S&P 500's forward four-week return following these instances has then never closed lower. The index has closed higher eleven out of eleven times for average returns of 3.62%. Further, only three of eleven instances closed a calendar week lower than the signal date close at any point over the forward four weeks. In the world of stocks they say "strength begets strength", and that certainly appears to be the case for strength in the month of October.

Now, we'd be remiss in not pointing out that there are no election year Octobers in the above table, meaning it's not the norm for the market to be this strong in advance of an election. However, as the great Wayne Whaley would say, when the market goes against a historical tendency, follow the market. In other words, the market is showing strength over a time period it doesn't historically show strength. The interpretation is that we should expect strength to continue, not for sudden weakness to arrive.

As for market internals, the big takeaway this week was the market demonstrating "gobs of breadth" as Tom McClellan would say.

In last week's Update we wrote about last week being a week of "rotation" and that a key to the S&P 500 climbing its way back toward the ~3,600 level and beyond is if we can have a stretch run where everyone is doing their job. Well, everyone did their job this week.

Ten out of the eleven sectors within the S&P 500 gained 2% or more this week. The materials sector was the top performing sector, gaining 5.07%, with energy coming in second with a weekly gain of 5.05%. Technology, utilities, and health care all gained 4% or more. Consumer discretionary, financials, and the industrials all gained 3% or more. This week's surge was a glimpse of how strong the market can be in the event there's a bid for both the technology sector and the financial sector (an example of a broad-based rally).

Quantifying "gobs of breadth", we recorded another Whaley ten-day, two-to-one breadth signal (ADT10) on Thursday. Whaley shared the S&P 500's historical performance following all prior ADT10s. Following ADT10s, the S&P 500's forward 3-month, 6-month, and 12-month returns have closed higher 82%, 87%, and 92% of the time respectively. The rationale behind this is that when market participants, collectively, are this eager to own stocks in the present, it's because their work is leading them to have conviction in the idea of higher stock prices into the future.

(Send Wayne an email at waynewhaley.witterlester@gmail.com to subscribe).

For the week ahead, the path is clear to retest our all-time highs.

While we're always just a tweet away, the only level of known resistance left on the daily chart is ~3,580.84 on a closing price basis and ~3,588.11 on an anytime basis. We'd like to see the S&P 500 "retest" its all-time highs. We now have ascending moving averages across the board, from the 5-day to the 10-day to the 20-day, so there's plenty of perceived "support" just below Friday's close. Hopefully our two-week winning streak can make it to three!

S&P 500 Primary Trend - Up

Our work continues to label the primary trend for the S&P 500 as up or "bullish".

During primary uptrends, long-term investors are best served investing in the more traditional sense of the word. Generally speaking, the recipe for success during primary uptrends is an equity overweight across your portfolio's asset allocation (i.e., investing more in equities than any other asset class) and relying on mostly passive investing methodologies. As the great Jesse Livermore emphasized, long-term investors need to learn how to sit tight. Jesse was quoted as saying:

"After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It was always my sitting. Got that? My sitting tight!"

Being technical students of the market, and firm believers in behavioral finance, we believe the price action of the market tells us everything we need to know not to predict where the market is headed (that's impossible), but instead to build a prudent and intelligent portfolio or asset allocation. Right now, it's telling us to sit tight with an equity overweight. It's imperative long-term investors find a way to listen. It's noisy out there.

Now, an equity overweight and passive investing methodology is a recipe for disaster during primary downtrends for the S&P 500. So, we don't believe investing for success over the long term is as easy as one set asset allocation and portfolio glide path. Ironically, there is no better time to plan for a primary downtrend for the S&P 500 than when the index is in a primary uptrend.

While we implore our readers to be right and sit tight at the moment, we also implore you to have a plan to manage the risks associated with a meaningful equity market drawdown.

Perhaps they're not needed for a long, long time, or maybe they're going to be needed in 2021. We have no idea, but it's better to have a plan to manage "bear markets" and not need it, than to need a plan to manage "bear markets" and not have it. It's also easier to sit tight if you know you have a plan in place to manage the risks of sitting tight. So, the key word here is to plan. There is so much we can't control as long-term investors, but having a prudent long-term investing plan (Investment Policy Statement) isn't one of them.

Small Caps Join The Party

The S&P 600 Small Cap Index (SML) gained 5.66% this week with Friday's close at 926.19. Friday's close is the highest close for SML dating back to March 2020.

SML has been a laggard for years, but it's starting to outperform...finally. SML has gained a whopping 12.59% over just the last twelve trading days. The index is still decidedly below its all-time high weekly close from 2018 at 1,098.36, but this might actually be a good thing. If participants are looking for a catch-up trade, look no further than SML.

So, not only do we have "gobs of breadth" for the constituents within the S&P 500, we now also have eager buying interest for the smallest of market capitalization stocks.

Small cap stocks are a measure of risk appetite across market participants and are often deemed to be a better economic barometer than their large cap counterparts given their cyclicality and domestic economic sensitivity. Participants are seemingly eager to own any and all stocks at the moment and that's as good of a tell as any regarding the prospects of higher prices into the future.

As we mentioned earlier, SML has been a major laggard compared to the S&P 500 the last three years. The ratio chart below shows how the S&P 500's returns have been greater than SML's returns for years. However, the ratio has built a base (yellow shaded region) and has at least recorded higher lows over the last seven months (upward sloping blue line). The best we can say now is that the bleeding has stopped, SML is at least keeping pace with the S&P 500. Should the ratio eclipse the 0.2721 level, then we can get a bit more excited about the prospects of SML relative to the S&P 500. Importantly, we do believe this will happen over the months ahead.

Finally, we believe many investors and participants are underestimating the possibility of an economic bonanza in 2021.

Continued accommodative monetary policy, further multi-trillion dollar stimulus (which we believe is all but certain), ascending confidence re: COVID, and the collective desire for our new normal to not be that far removed from our old normal is the narrative. In the scenario where this narrative is more right than wrong, we believe SML will show leadership relative to the S&P 500.

Bonds Breakdown But Gold Finds Its Footing

We titled a section in last week's Update "Gold Holds Steady, Bonds Poised For Huge Move", and with the luxury of hindsight that's sort of what we saw this week.

Long-term Treasury bonds (USB) closed down on the week by -1.11%.

USB has broken down below its lower Bollinger Bands on its daily chart, but it is at least in an area of support based on its closing lows from August and June. It's imperative USB finds a bid here in the short term, or else we'll be reading articles about interest rates breaking out to the upside over the week(s) ahead. The yield associated with USB could actually rise to challenge the 2% level. We never thought we'd ever type that...

With USB selling off again this week (its third weekly decline over the last four weeks), yields moved higher across the long end of the yield curve. The interest associated with USB closed Friday at 1.57% this week, a weekly increase of 6.28%. What we found interesting here was that gold didn't sell off in response to rising interest rates.

Gold actually gained 0.98% this week with Friday's close at $1,926.20.

The metal traded as low as $1,877.20 on Wednesday, but then managed to finish the week on a positive note into Friday's close. For now, gold appears to have held rather pivotal support, with the trade down to $1,851 in September appearing as a false breakdown.

While gold got a tailwind from a second consecutive weekly decline in the U.S. Dollar Index this week, gold's price action this week also continued a recent trend of showing a somewhat positive relationship with the yield associated with USB.

The price of gold (gold line) and the yield associated with USB (blue line) are plotted on the chart below. Notice how the peaks and troughs from May through August appear opposite one another (i.e., gold bottomed when yields topped and gold topped when yields bottomed). However, notice the relationship in the blue circle: the peaks and troughs for both gold and yields now appear to be occurring in close proximity to one another with both having bottomed on September 25th on a closing price basis.

The narrative here is market participants finally lifting inflation expectations.

In any scenario where market participants actually believe the Fed and global central banks will succeed at boosting inflation, while simultaneously saying they're going to keep interest rates across the yield curve low, then the trade is to sell bonds (yields rise) and buy gold. This is a fancy way of saying the future includes a prolonged period of negative real interest rates and that's a backdrop that's been very supportive of higher gold prices over time.

For the remainder of October, if gold can make its way into the yellow highlighted region on the chart below then we'll be of the opinion that new all-time highs for gold are just around the corner. Fingers crossed!

Happy Sunday!

Steve & Rick

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