The S&P 500 roared 4.91% this week with Friday's close at 3,193.93.
We ended this section of last week's Update with a series of questions that read:
"Can the S&P 500 extend into the 3,100's and close all five trading days above the 200-day simple moving average?
If it can, the touchdown will stand.
If it can't, the points the index scored this week will be coming off the board.
The S&P 500 hasn't recorded a three-week winning streak yet in 2020. Perhaps the first one is only five days away."
The answer was yes, and emphatically. The touchdown stands, the crowd went wild, and the index has all but left the crash we witnessed in March as nothing but a bad dream - with the blink of an eye it's over, as if it never happened.
We have written the phrase "the market trades beyond the limits of imagination" hundreds of times over the last decade, and the last three weeks are a perfect illustration. Fifteen trading days ago the S&P 500 was trading in the ~2,700's after finding "resistance" at and around widely followed levels of "resistance", especially during "bear markets". If on May 15th you told us that we'd close June 5th at 3,193.93, we would have laughed rather loudly and uncontrollably.
The breakout is confirmed, and emphatically.
The S&P 500 recorded some history the last three weeks. The index has now increased 3% or more for three consecutive weeks. We've only seen this happen one other time since 1950, the week ending 09/03/1982.
In terms of momentum, the index has now gained 11.53% (closing prices) during our three-week winning streak. When examining all other three-week winning streaks that ended with returns of 10% or more, we can see that the last time this happened the S&P 500 got absolutely smashed the next month. However, most other instances showed upward momentum persisted, especially over the forward three-week period.
We found this table to be a perfect reflection of the conundrum many investors face at the present moment: Exercise patience and adherence to a disciplined process, or panic buy Monday's open in an effort to "chase" and capture any continued upside momentum?
At the moment, "FOMO" (an acronym for "fear of missing out") is running wild across sentiment. You probably feel it, we definitely feel it, almost everyone feels it. Collectively, it's as if everyone is "under-invested and terrified" and of the opinion that the S&P 500 will never experience another -5% pullback, or -10% correction, again.
Many measures of speculation are running as hot as they've ever been. Equity call option volumes on the Chicago Board of Options Exchange (CBOE) are skyrocketing, leaving the equity put/call ratio (the ratio of puts purchased to calls purchased) at and below 0.50 across the last 5, 10, and 20 trading days. In other words, participants have been buying twice as many call options to put options consistently over the last month.
We've only seen this type of activity a handful of times over the last 15 years: 2010, 2011, 2014, and early 2020.
This type of lopsided activity preceded 2010's "flash crash", 2011's summer meltdown, October 2014's swift -10% correction, and 2020's crash. Excessive speculation usually doesn't end well, no different than getting off to a fast start at the tables in Las Vegas - you just know the luck runs dry.
Importantly, this degree of speculation in the short term hasn't meant a meaningful reversal lower was imminent over days or weeks, but it's always suggested the S&P 500's forward returns will lack durability over months, i.e. "FOMO" is misguided. Remember, "FOMO" is the idea of "missing out", the idea that you've missed an opportunity that you'll never get back again. We find it hard to believe that the S&P 500 won't trade below 3,000 again at any point during the remainder of 2020.
In actuality, the most durable returns occur from remarkably "oversold" conditions, when nobody has "FOMO" but instead is overwhelmed with the fear of losing money. We have no problem believing that the S&P 500 won't trade below 2,400 at any point during the remainder of 2020.
At the moment, we're not "remarkably oversold", but instead are marginally "overbought" with speculation running rampant. We can see this persisting in the short term, but even if the index trades up to 3,300 this week, and 3,400 the week after, and 3,500 the week after that, the euphoria will be bubble-like. If the index then records nothing more than a standard -10% correction the following weeks - its price will be 3,150, or -1.3% below Friday's close. Nobody will have "missed" anything. Further, a standard -10% correction isn't what you expect to see after a bubble-like, parabolic advance (reference the tech bubble).
Looking at the short term, there's definitely reason to believe the S&P 500 can make a dash at "re-testing" its all-time highs over the weeks ahead. If we invert or flip the chart of the S&P 500 upside down, there's a gigantic bullseye right at March's all-time high, it's the only "resistance" left on the chart. The picture below is that of an asset in free fall, and few would argue this chart is ripe for a reversal higher at this point - we'd all be looking for it to continue to fall right into the ~3,390 level, where we'd then want to buy it like mad.
Pairing the current price action with the forward-looking economic landscape, we continue to believe this is the greatest disconnect the world has ever witnessed. The S&P 500 is either pricing as if there is certainty and complete conviction in a roaring economic recovery that will catapult earnings per share to decided new all-time highs, or it's pricing off a tremendous degree of speculation that we've previously detailed.
The roaring economic recovery narrative gained some momentum on Friday with the jobs report revealing the economy added 2.5 million jobs in May, the most jobs the country has ever added in a single month. Consensus economist forecasts were expecting job loss of roughly 8-9 million, so Friday's upside surprise certainly played a role in catapulting markets to the upside. Ironic, since the report is probably nothing more than funny math.
While the economy probably did bottom in the first half of 2020, the magnitude of the S&P 500's advance the last three months isn't aligned with the fundamental progress we can reasonably expect the second half of 2020, and we're still not even convinced earnings per share in 2021 will match that of 2019.
Naturally, there is a ton of forward-looking risk to behavior in the present that's either based on complete conviction in a roaring economic recovery (i.e., a perfect scenario), or incredible speculation. In any scenario where the future isn't perfect, and there isn't a roaring economic recovery, the S&P 500 will "correct" the excessive optimism it displayed in the May and June time period. Speculation then becomes a plausible accelerant to the "correction".
Two months ago, virtually nobody expected that we'd be where we currently are - we know we certainly didn't. Our bet is we'll be able to type this again two months from now, one way or the other.
S&P 500 Primary Trend - Neutral to Up?
The S&P 500 has kicked off the month of June roaring to the upside. The index is now in position to retest its all-time high monthly close from December of 2019, and perhaps close the month of June at an all-time high. This will label the primary trend as up or "bullish", and certainly record as the single greatest V-shaped market recovery we've ever seen. The S&P 500 has never come close to erasing a -35% drawdown in matter of three months, but here we are. We live in unprecedented times, and we're witnessing unprecedented price action.
There is still an eternity left in June, and based on May's monthly close the primary trend is "neutral", or trendless. Long-term investors remain best served aligning their portfolio with the primary trends across asset classes. The price action the remainder of June will undoubtedly be pivotal one way or the other. A reversal the remainder of the month would certainly maximize uncertainty, while a continued advance the remainder of June will reassert the primary trend as up or "bullish".
Following up with last week's review of the performance of the S&P 500 Equal Weight Index compared to the traditional market-cap weighted S&P 500 Index, equal-weight scored a decisive touchdown this week - breaking out right alongside the S&P 500.
The generals are still strong, but the troops are finally joining the party. After this week, it's hard to argue it's just a technology and healthcare party anymore.
We also recorded a "Whaley 10-day 2 to 1 breadth thrust" on Friday. This is defined as any rolling 10-day period where the sum of the S&P 500's advancers is more than twice as many as the S&P 500's decliners. This is viewed as "accumulation", and as we wrote last week, if the price action in the present reveals valuable information re: the forward-looking expectations of market participants (a huge "if" given modern market structure), then there's only one reason why participants would eagerly bid stocks as strongly as they have the last three months - they expect higher prices into the future.
Wayne Whaley shared the historical returns of the S&P 500 following a "Whaley 10- day 2 to 1 breadth thrust" on the table below. The S&P 500's forward 6- and 12-month returns have closed higher 87% and 92% of the time, respectively. This hasn't precluded the index from occasionally pulling back meaningfully over the forward 3-month period, but it does support the idea that should a pullback occur at some point over the forward 3 months, investors are best served to "buy the dip". (For more information on Wayne's commentary visit www.witterlester.com).
As always, there is a very, very wide range of future outcomes for the economy and markets.
While the price action in the S&P 500 is saying that's not the case, remember that the S&P 500's price action in March told us that the world was ending - it was clearly wrong. *Anything is truly possible*, we may or may not be out of the woods, and we won't pretend to know what lies ahead. We've been humbled many times over the last decade, and now is a time for humility. Conquering ourselves helps us be totally dispassionate long-term investors and eliminate bias or emotion from influencing our investment management process. We believe this will help optimize performance over the long term by controlling what we can control, and help investors adhere to their long-term investment plan during the most uncertain of times...times when they may consider abandoning their long-term investment plan...times like now.
Bond & Gold Update
The bond market finds itself in an interesting position at the moment. The price of a 30-year United States Treasury bond (USB) closed Friday almost exactly on its 100- day simple moving average, after having traded considerably below it during Friday's session. USB has closed red 8 of the last 9 trading days and closed Friday decisively below its lower daily Bollinger Band, so it will be interesting to see if participants "buy the dip" in USB over the week ahead.
USB's decline has left interest rates ascending. USB is presently yielding 1.68% after having traded up to 1.76% during the session on Friday. 1.76% on Friday was basically right at March's high where USB last found meaningful buying interest.
We'll hear from the Federal Reserve this week, and with interest rates rising it will be interesting to see their commentary re: "yield curve control" (click here). The Fed is not going to risk losing control of the yield curve in our opinion, and while some steepening is probably viewed favorably, excessive steepening will undoubtedly be a headwind to any economic recovery - and the curve steepened excessively this past week.
The yield curve (10-year Treasury bond yields less 2-year Treasury bond yields) exploded higher this week, rising by 40.82% and is now face-to-face with the last known levels of resistance on the charts over the last four years.
With the short end of the curve anchored to 0%, it would seem as good a time as any for participants to bid 10-year United States Treasury bonds, especially if one believes that higher interest rates in the present will only bring more Fed bond purchases into the future. The Fed has been open about how uncertain the future is, unlike the price action in the S&P 500, so it will be interesting to hear their tone on Wednesday.
The price action in bonds always influences the price action in gold as interest rates are a measure of the metal's relative attractiveness. Gold tends to move in relationship to real interest rates (i.e., the differential between the rate of inflation and the yields associated with treasury bonds). Negative real rates, a predicament in which the rate of inflation is greater than treasury yields, is a favorable fundamental backdrop for gold. We believe this is why gold has performed very, very well over the last few years as real interest rates have been negative and global central banks continue to behave in the present as if their mandate is "inflate or die".
However, the move higher in interest rates the last few months has stymied gold's advance. Gold traded down -3.92% this week, but the metal did find support at and around the ~$1,672 price region, which was "resistance" in the early March time period. It fuels the old theory of "past resistance becomes future support", even if only temporary.
The chart pattern in gold remains constructive and appears along the lines of a "flag pattern".
While we don't believe chart patterns have any significance, we recognize that others believe chart patterns have significance and therefore they can drive the collective behavior of participants. Perception is often reality.
So, it's a pivotal week for bonds and gold. Both have outperformed the S&P 500 over the trailing ~20 months, marking them a valuable component of a diversified portfolio. But the question is whether they will continue to be a valuable component of a diversified portfolio. If that's to be the case, then we expect them to perform positively over the week ahead.
Steve & Rick
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