This Week's Message: Rally Makes Sense, Not Out of the Short-Term Woods, and Long-Term Continues to Look Good...

In Saturday's blog post we said that the backdrop for equities is such that if the U.S. protectionist push 

"doesn't get drawn out long enough to crack the general setup we'll see a sharp rally in stocks, likely to new highs." 

Of course new highs are a ways off, but a sharp rally aptly describes what we saw yesterday on the heels of the breaking headlines we featured in Sunday's post:

Mnuchin `Hopeful' Truce Can Be Reached With China on Trade 

 U.S. and South Korea Reach Agreement on Trade, Steel Tariffs

So, am I suggesting here that we are uber good at predicting short-term market action? Heavens no! But we are always happy to state the obvious; which at the moment would be that the market utterly, and justifiably, hates home-grown protectionism. 

On that, here's from this morning's entry to our internal market log:

In terms of equities in general, the strong macro setup – and the recent correction – virtually demands that the market rally hard on news that the administration is coming to its senses.

Of course we’re not out of the short-term woods as of yet; yesterday’s rally was predicated on the potential that the China tariffs won’t happen and that NAFTA will survive. Both scenarios will need to become reality to unshackle the market heading into the often seasonally tough summer months…

The "strong macro setup" comment stems from our analysis of general economic conditions, technical indicators that reflect long-term price trends in various asset classes and sectors of the economy, as well as trends in the intermarket relationships among various asset classes and sectors. 

In terms of general economic conditions, our proprietary macro index came in this week at +49.38; which reflects a large 12.35 point decline from a week ago. The notable drop reflects last week's drubbing of the equity market; as the financial markets subindex (which plummeted 33.34 to points to a +4.76 reading) comprises 25% of the overall index. 

The factors that hit the financial markets subindex were, ironically, a little too much bullishness reflected in the investment adviser sentiment index we track (that's a contrary indicator), a large spike in the CBOE "Skew Index" (increases when options traders turn bearish on the S&P 500), a jump in the CBOE put/call ratio (another measure of risk sentiment in the options pits), the out-performance of bonds over stocks last week, and the breakdown in breadth that often occurs amid market selloffs. The one improvement in the subindex was U.S. equity valuations; last week brought the market's forward price-to-earnings ratio into our green (attractive) zone; had been in the yellow (comfortable).

Of course if yesterday's rally is an indicator of what this week has in store, next week's financial market reading will come springing right back.

For a feel for what a 49 overall score looks like historically, here's a chart reflecting 20 years worth of back-testing:

click to enlarge...

NOTE: We make no claim that our macro index will anticipate the next recession and/or bear market before it occurs. It simply serves as an ongoing reflection of general conditions and instructs us as to probabilities (but never assurances) going forward.

While 49 is a far cry from the 76 recorded just a few weeks ago, historically speaking, it (along with other things) has us sticking with our overall growthy sector allocation for the time being...

Have a nice week! 
Marty