The Dow Is The Most Overbought Since 1904

End Of The Streak- Stocks Still Overbought

The stock market finally ended its remarkable run to start the year, but stocks are still euphoric. This 0.11% selloff in the S&P 500 only ends the streak; it doesn’t make stocks less overbought. As you can see from the chart below, the 14 day RSI on the Dow Jones Industrial Average was the highest since 1904. These types of indicators are tough to analyze because stocks being extremely overbought in the near term doesn’t mean much for returns in the next 6-12 months, but it seems like these records are being broken all at once especially since this is the longest string of positive monthly returns in the S&P 500 and next week it will become the longest streak without a 5% correction. When looking at these stats, if the metric isn’t at a new record, it’s surprising. Records falling is the norm as this is the Wayne Gretzky of bull markets.

Inflation Looking Like It Might Increase

We’ve discussed that the inflation rate should increase in 2018. The 10 year break even inflation rate recently rose to 2.05%. As you can see from the chart below, the year over year core CPI has some correlation with the year over import prices and the dollar index. Import prices for consumer goods went from a source of deflation to one of inflation. The dollar index is advanced 4 months ahead showing its recent correction might mean the core CPI will increase. The December CPI report will be released on Friday. The expectation is for a 2.1% increase year over year which would be a decline from the 2.2% growth in November. The core CPI is expected to increase 1.7% year over year which would be flat with November. I am looking for it to beat expectations.

Commodity Pressures Usually Cause Problems

It’s funny to see investors keying off the Fed by complaining about low inflation. These low commodity prices have been the fuel for the rally in the past 2 years. The chart below shows the commodity prices compared with recessions. As you can see, when they spike, it’s bad news for the economy. This cycle is slightly different because some regions benefit from high oil prices because of the fracking boom in America. We might be seeing the benefits of balance economy because consumer spending was helped by the oil crash, but the energy sector was killed. Now energy firms are benefiting from higher oil prices which will start to hurt the consumer. If the labor market brings wage growth partially because of the improvement from the energy sector, the consumer will probably be able to handle the increases.

The CRB commodities index is at $194.86. It’s a couple points away from starting a new uptrend. If it rallies that much, it will be at the highest point since late 2015. Oil prices are driving the index higher as oil went up again on Wednesday. It was up 1% to $63.57 which was a 3 year high. The price went up because crude inventories increased 4.9 million barrels last week which was more than the 3.9 million expected. Counteracting that good news was the build in gasoline. Gasoline stocks increased by 4.1 million barrels which was more than the 2.6 million expected. The distillate stockpiles went up 4.3 million which was more than the expectations for a 1.5 million barrel increase.

Earnings Season Unofficially Starts Friday

There’s no official start of earnings season. It all depends on which companies you follow. With JP Morgan and Wells Fargo reporting on Friday, I think that’s a reasonable starting mark. That being said, there have been a few reports from companies which can give us a signal where the economy is headed. Lululemon gave investors a feel for its holiday sales on Monday. The company had such a good quarter that it raised guidance. Revenue guidance went from $870 million- $885 million to $905 million-$915 million. EPS guidance went from $1.18-$1.21 to $1.24-$1.26. The stock went down 0.49% on the news as investors already had it priced in. That’s a scary signal for firms who miss expectations. Stocks might be priced for perfection. In the past couple quarters, stocks have sold off after beats. The good news is the indexes increased even with that disconcerting action after earnings reports.

Crypto Mania Dips

In the past few days, the total market cap of all cryptocurrencies has fallen about $100 billion as it’s now at $730 billion. The bottom chart below shows the drawdowns in bitcoin compared to the drawdowns in the commodities index, the emerging markets index, and the S&P 500. It’s no surprise to see the size of the bitcoin declines much larger than the other assets. I thought that bitcoin would become less volatile as it got older and bigger. This hasn’t happened as the main reason for the recent adoption is currency speculation. New users can claim they are new adopters as part of a trend, but all they are doing is pushing the price up. Bitcoin being mostly used for speculation has made me less interested in it.

The chart on top shows the recent trend in ICO activity. The biggest deal ever is coming up as the messaging app Telegram, which has over 200 million users, plans to raise $1.2 billion through an ICO. The last major ICO was KIK which is another messaging app. As the size of these ICOs grows and bigger companies try them out, we’ll see the potential long term use case. Telegram wants to have its own coin used on the app to allow money transfer across borders to be easier. The concept of major companies having their own coin is interesting. It’s sort of like a derivative on the stock. If Telegram’s user total grows, more people will use the coin and the value will increase. The problem is when speculative bubbles form based on no fundamental change. I’m not writing off all crypto, I just think the speculative rallies in bitcoin and the other altcoins are unsustainable.

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