In late March of this year, I wrote an article saying that even though the coronavirus numbers might get worse, it doesn’t mean that the stock market has to go lower. I followed it up with an article in mid-April titled: “The market might be forecasting a faster recovery than we expect.”
What gave me the conviction to write those articles was the price action of the market and its leading stocks. The big institutions control the market and interpreting what they are doing on a regular basis is far more powerful than listening to the news every day.
Currently, the price action is telling me the stock market will head higher into the Presidential election for the following reasons:
1) There is very little distribution. Distribution is a fancy word for professional selling. The simple definition of a distribution day is a down day on higher volume than the previous day. Since the March lows, we’ve seen some distribution days here and there, but no consistent follow through selling. This is important because in order to see a market top, we need to see several distribution days in a 3 to 4 week period. Until this happens, I am sticking with the trend.
2) Strong technicals. On a longer-term timeframe, the 10-week moving average is historically known as an area of institutional support. Right now, all the major indexes are above that key level. From a shorter-term view, strong stocks and strong markets tend to hold their 21-day moving averages and the Nasdaq Composite has done so since early April.
Chart is provided by MarketSmith
3) The Fed. There is a globally coordinated effort to keep interest rates low and the markets high. It’s not our job to argue with it, it’s our job to take advantage of it. The Federal Reserve is providing an insane amount of liquidity to make sure businesses and the economy recover from the recent downtown. As a result, this liquidity is also providing an equity friendly environment. There’s a reason the late Wall Street legend Marty Zweig said “Don’t Fight the Fed.” It’s not worth the aggravation fighting a machine that is determined to see the economy and the markets recover.
4) The leaders. Unlike 1999, the current market leaders have pristine balance sheets and earn a tremendous amount of cash. These companies continue to dominate internationally and have actually seen their businesses improve as a result of more people working from home and the increase in e-commerce. I follow unusual option activity and many of these stocks have seen non-stop bullish bets that they will be higher over the next 3 to 6 months. In addition, many money managers are underperforming on the year and if they are forced to chase this market, they will likely gravitate towards the Mega Cap names because they are liquid and have reliable earnings.
5) The election. President Trump wants to get re-elected. This is not a political statement, this is a common sense statement. In other words, any one running for re-election will do everything in their power to get re-elected. In President Trump’s case, this will include various tax cuts and keeping pressure on the Federal Reserve. In fact, there are already rumors that the Fed will provide additional stimulus at their upcoming September 15-16th meeting. Again, don’t argue with it, just do your best to take advantage of it.
Here are some counterpoints. I am always flexible with my approach to the markets. One of my favorite quotes from hedge fund legend Stanley Druckenmiller is: “Probably one of my greatest assets over the last 30 years is that I’m open-minded and I can change my mind very quickly.” In other words, if any of the above points change, such as distribution building up or the leaders breaking down, then I will shift to a more defensive posture for clients.
Another challenge is the increasing bullishness in many sentiment measures. My feeling is the market will occasionally “shake out” this exuberance with pullbacks along the way. Since the March lows, the market has seen several short-term pullbacks of 5-8% and this pattern is likely to continue just to keep the bulls in check. That is why it is so important to know your timeframe. If you are a shorter-term trader, one way to deal with this pattern is to take profits into strength and have some cash available for the inevitable pullbacks. If you are a longer-term investor and you have strong entry points on your investments, then you have to be patient and sit through some volatility along the way. Again, these are decisions that need to be made based on your own investment objectives and risk tolerance.
Similar to the articles I wrote in late March and early April, I am mainly making this call based on the price action of the market and its leading stocks. The large institutions — mutual funds, hedge funds, pension funds, etc. — control the market and interpreting what they do on a regular basis is very important. (If you are looking for help with this type of market education, you can find more at my website.)
The bottom line is the trend is higher into the election and I’m going to stick with it until the market tells me otherwise.
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