Rally Reaches Insane Proportions: Raise Cash!

Insanity Continues

This bull market insanity continued on Friday as stocks rallied again! The stock market has momentum and the calendar effect is strong. However, this rally has gone too far. This is the exact opposite of December 2018 when stocks were cratering. 

It’s important to note that stocks exploded in 2019 because they started the year cheap. The economy actually didn’t have a great year and earnings barely increased. I won’t be unjustly harsh on 2019. The consumer was strong, the labor market was strong, and the housing market rebounded.

There were some good aspects to the economy this year. However, the main reason stocks rallied is because investors were caught betting on a recession, when all we had was a slowdown. Plus, the Fed stepped in and saved the day. 

Point is if 2019 can have a mediocre economy and a fantastic stock market, then 2020 can have a solid economy and a weak stock market. It’s very tough to bet against stocks in a year where I expect an economic rebound, but I certainly wouldn’t be overweight U.S. big caps. I would raise cash at the very least.

Specifics Of The Impossible Rally

S&P 500 has reached what must be close to peak euphoria. It is up 10 of the past 13 days as it increased 0.49% on Friday. It’s up 4 weeks in a row. CNN fear and greed index increased 1 point to 91 which is extreme greed. It’s very close to its November peak. Difference between now and November is stocks are more expensive. That doesn’t seem to mean much to investors now. But it always means lower returns are coming in the intermediate to long term. 

On the bright side, since then we have more clarity on trade. But the deal was more of a truce than a long term commitment to open trade. As of Thursday’s close, the 14 day RSI was at 74.23. With Friday’s rally, it came very close to the November peak.

VIX increased 1 basis point to 12.51. It’s still very low, but can’t go much lower. It’s a great time to go long volatility. I wouldn’t go long for all of 2020. This is just a January trade. If stocks decline in January, almost every prognosticator is going to claim the year will be terrible. But I don’t give much weight to such tendencies. 

It will be healthy for the market to selloff about 10%. And it will restore sanity. We’ve never seen a more euphoric rally because January 2018 had more euphoria. However, this increase has gone too far. I have been hesitant to call for a correction in December. 

Stocks usually don’t crater right before Christmas. I think the decline will occur in January. Finishing off this discussion on how overbought the stock market is, the NSYE advance decline line has increased 12 straight days. That’s the best run since June 2003. You need to go back to early 1991 to find a better run.

Core Inflation Fell

Let's discuss the core inflation part of the November PCE report. Headline PCE inflation was 1.5% which met estimates October PCE inflation rate was revised from 1.3% to 1.4%. And, October core PCE inflation was revised higher by 0.1% to 1.7%.

As you can see from the chart below, in November core PCE inflation fell to 1.61% which met estimates. Differences in the action in headline and core PCE inflation was all about energy. I think in 2020 we will see headline inflation rise back above core inflation. 

A 5 basis point decline in core PCE inflation put it at the lowest rate since June. The comp was 10 basis points tougher, so the 2 year stack was up 5 basis points. Remember, PCE doesn’t calculate healthcare inflation like the CPI report, so it is almost always lower.

The report isn’t close to what’s needed to get the Fed to hike rates, not that most investors are looking for a hike. More are looking for a cut than a hike. There is a 54.7% chance of a cut and a 1.9% chance of a hike in 2020. A hike is likely the next move, but it will happen in 2021. 

Core PCE inflation should start to increase once the comps get easier in early 2020. It’s double trouble because the economy should start to strengthen as well. The easiest comps will be in March and May which had 1.48% core inflation. Inflation will likely hover around 2% in those months in 2020, but it depends on how much growth accelerates.

Details On Friday’s Action

Nasdaq rose 0.42% and the Russell 2000 rose 0.29%. That’s another record for the Nasdaq. Russell 2000 is closing in on its record from August 2018. It should hit it in early 2020. Now, I expect the Russell 2000 to outperform the S&P 500 because the yield curve will steepen and rates will rise. 

Plus, there won’t be a Fed rate cut like some think. I was betting on the regional banks in 2019 and it didn’t end up terribly. KBW regional bank index is up 23.17% year to date. That’s not as good as the S&P 500’s 28.5% increase, but it certainly didn’t go wrong.

Every sector was up on Friday. The rally was very broad based as no sector was up 1% or more. Best sectors were energy, healthcare, and the utilities which increased 0.88%. 0.78%, and 0.78%. Healthcare may have rallied because of the Democratic debate. I don’t know if that makes sense. 

It seems like Buttigieg did badly and Sanders did well. Overall, Biden will probably still lead the polls though. Finally, the 10 year yield stayed at 1.92% as it still can’t get above the mid-1.9s. I think it will hit 2% very soon. 2 year yield closed at 1.63%, so the difference between the two is 29 basis points. 

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1 Comment

  • Kevin Morgan

    December 23, 2019

    Technicals indicate this is an early stage secular bull market run ( coming out of the 1.7 year consolidation range). Elliott wave analysis indicates this is the early stages of a cycle V wave up. All kinds of analogue set up analysis gives statistics showing we should expect very strong markets for the next 2-5 years. So there are a lot of confirming indicators of bull conditions. So I'm very bullishly biased. That said, in the short term, yes this minor 3 wave up is very near completion, and a minor 4 should start in hours or days to correct sideways/down for 2-3 weeks most likely, and back to the range of the prior minute iv (3074 to 3153). That will be a great opportunity to sell some overhead call spreads for mid-Jan expiry. But then the expectation is for a minor 5 to new highs, then a intermediate 4-5 sequence, then a primary 4-5 sequence, each taking price down then up to new highs again. So a generally rising market with steadily increasing volatility (most probable anyway; anything can happen, the future is unknowable and can only be estimated).