Is the Stock Rally Eclipsing Market Risk?

It was July 1991. My wife and I were leading a band of more than 100 shadow chasers to the Big Island of Hawaii. We were journeying there to watch a solar eclipse from American soil.

At the same time, to the southwest of us, the travel company that I owned a part of, Love to Travel, Ltd., was sailing along the path of totality. The voyage was on a brand-new Royal Caribbean cruise ship filled with over 200 travelers, including the CNN TV crew, who would televise the event to much of the rest of the world.

Two years before, I knew nothing about the upcoming eclipse. But then my two partners in the travel company came to me and suggested the sponsorship of the 1991 eclipse adventure—the first eclipse viewable from the United States since 1979. They told me how for over a century Americans had been chasing solar eclipses and how this was going to be a big event, especially for the astronomical societies throughout the country.

Up to then, our company had been merely sponsoring trips to sporting events—baseball playoffs and big out-of-town football contests. We’d learned to cope with hotel and travel reservations and unruly and often inebriated fans. Each of us had taken a turn at being tour directors. We thought we were ready for the challenge.

By the time June 1991 arrived we were not so sure. Sales had been slow for the 300-plus eclipse tourist spots we needed to make the event a success. Our ads in astronomy magazines had not done the job. In response, I had had to temporarily leave the office and travel to astronomical societies around the country to make the eclipse travel pitch (my largest presentation was to a crowd at the Adler Planetarium in Chicago).

To make matters worse, the cruise company was having trouble (a labor strike) finishing its construction of the cruise ship that we had wholly reserved for its maiden voyage. It appeared that the people who had already signed up for this once-in-a-lifetime event, including many of America’s pre-eminent astronomers, would miss it.

Finally, out of necessity, I had to personally guarantee the trip costs to the cruise company. It amounted to almost my entire net worth!

I was totally on the hook and facing ruin! Despite all of the excitement the upcoming eclipse was now generating around the world, for me, the eclipse represented nothing but risk.

I recalled stories I had heard about the Mesopotamians thousands of years before. The coming of the eclipse was then viewed with great fear. The sun was a god, and its loss was thought to be an omen foretelling the death of a leader.

As a result, their leaders would temporarily abdicate for 100 days around the time of an eclipse, becoming a “farmer” living in the palace. A condemned criminal would be appointed as a substitute. Once the eclipse was over, the then “leader” would be assassinated, and the “farmer” would retake the throne. Was I to be the “farmer” or the “leader” this time around?

But then, suddenly, with just weeks to go before launch, the reservations began to pick up. We hit our break-even mark and then soared to full capacity.

And on the day before the cruise was to set to sail, the harbor master of the Port of San Diego came on board and, finally, certified the cruise ship’s last outstanding launch requirement, the safety of the just-delivered new lifeboats. We were ready to put to sea.

The actual cruise and coincident land tour went off without a hitch. Although there were a few clouds on the Big Island as eclipse day, July 11, began, during the actual eclipse, the sun found an accommodating hole, and the view was cloudless throughout the event.

As predicted, at totality, the air did not stir, and the wildlife around us had all gone aground. When the sun began to reappear, it was like daybreak, and the birds began their wake-up sounds and rituals to greet the “new day.” Our clients, too, were all abuzz and congratulated us for putting together a successful event!

And the pictures of the total eclipse that CNN broadcast to an audience around the world from our ship were taken in a pristine sky, and they were sensational!

As we prepare for a new total eclipse here in America on August 21, I do fear that just as the possibility of great rewards in 1991 caused me to underestimate the risks I was taking, the rally in stocks during the run up to the new eclipse here could be obscuring to many the true risks of investing.

Stocks experienced their first real glimpse of volatility returning to the markets last week, as the world finally confronted the risk of North Korea’s nuclearization and transcontinental missile threat (although less than 15% of the intraday decline Tuesday occurred after the Trump “fire and fury” comment). The VIX (the “fear” index), that just two weeks before had moved down to rare single-digit territory, denoting almost zero perceived risk among investors, increased over 60% in a single day.

VIX Index: Last Three Years 08/16/17

On Tuesday, rather than extend the Dow’s nine-day record high close streak to 10 (it was already tied for the fifth-longest such streak in market history), stocks sank and over the next two days fell more than 300 points, as measured by the Dow Jones Industrial Average. All of the major stock market indexes finished last week lower by 1% to 1.5%. Some sectors were down more than 2.6%. In contrast, gold gained 2.41% in a flight to safety that also increased bond prices.

While earnings season has seen more overperformance than under, it has been at the lowest rate of occurrence since the second quarter of 2014—although, absent last quarter, revenues beat expected performance by more than any other time since that same quarter in 2014.

Interest rates were lower last week, but expectations still exist in some quarters for a continuation of the Fed’s announced intention to push higher this year.

Economic reports beat economist expectations too, with seven reports outperforming to only three disappointing (we count the four below-expectation readings for inflation last week as a positive). And measures of business optimism returned to an upward path.

Although this was the first stumble experienced by stocks in more than a month, and bullish sentiment among small investors fell while the bears gained in numbers (from this week’s AAII sentiment indexes), I do not believe the end is at hand for the rally. Like at an eclipse viewing, we may just be observing the market through a piece of exposed film. It’s just not that clear.

The market’s still-mild volatility (it was only the fifth 1%-plus down day this year) historically points to higher prices for the remainder of the year, as does the market breadth’s ability to match the new highs, the level of year-to-date gains at this point in the yearly price cycle, and the future trek of market prices in similar (highly correlated) years (plus 10% in 1995, for example).

History tells us that even when a 50-day-plus period without a 1% daily move ends, if it ends with a 1% decline, the immediate future surprisingly is positive.

S&P Average Forward Performance 08/16/17

Focusing on our indicators may be of more help than these snapshots, though. While our shortest two indicators remain negative, they are recovering. And our intermediate-term indicators remain positive.

Remember that the best indicator is still the market’s trend, and that trend is still up.

Despite my belief that this rally still has farther to go to the upside, it is important to remember that just like there were great rewards possible if we at Love to Travel could carry off a successful eclipse event, disastrous results were also always possible.

The risks I survived in 1991 reinforced my belief that one must always consider risk, which is why I employ dynamic risk management when investing. Doing so, using disciplined, emotionless, computer-generated trading, has served me well through all of the ups and downs of the markets since then.

I hope all of the eclipse viewers next Monday will have the extraordinary experience our clients did back in 1991. As for me, I once again experienced eclipse risk. I was going to watch “totality” from Columbia, South Carolina, but my hotel reservations fell through, and replacements were all booked up. I’m glad my Love to Travel clients did not have to miss out like I will.

Back in 1850 B.C., there was another eclipse screw up. This time the “farmer” died as the eclipse arrived, and the criminal retained the crown! Yes, risk is always present.

May your eclipse travel plans be uneventful and the experience sensational.

Weekly Edge: ETF Relative Strength Indicates Change May Be Coming

Leadership among ETF sectors continues to lack organization, suggesting that domestic markets may be nearing an inflection point, as overall market momentum decreases. For the past two weeks, sectors and factors have suggested a slowdown in the equity markets. Now, global rankings are also suggesting a potential slowdown, as overall global momentum has decreased, and the riskiest geographic areas have decreased the most. However, generally speaking, these are shorter-term trends that may merely indicate a period of consolidation rather than an overall reversal in equity market direction.

Sectors: The leading Sector Benchmark ETFs exhibited relatively small shifts over the past week. Technology continued to lead, tied with Utilities, and Financials declined. The momentum scores of all sectors except Consumer Staples decreased for the week; however, only Materials and Energy were negative. The spread between the highest and lowest increased from 34 to 42. In terms of ranking organization, there appears to be no general trend between cyclicals and defensive sectors. Technology (a highly cyclical sector) performed as well as Utilities (a typically defensive sector). Materials was the only sector to change from positive to negative for the week, suggesting a potential slowdown in the economy. That, coupled with an overall decrease in momentum for each sector (except Consumer Staples), also suggests the potential for a market slowdown.

We appear to be approaching a potential inflection point in the market. Consumer Staples was the only sector to increase momentum last week, while Energy and Materials are at the bottom of sector rankings. Overall, there appear to be more signs pointing to a slowdown than a continuation of the momentum that we’ve seen for the year so far.

There are some specific concerns for certain sectors that may be affecting their rank. The overall lower price of oil has caused the Energy sector (typically cyclical) to fall near the bottom of rankings. Increased political uncertainty from the administration’s threat to withhold payments from insurance companies may have caused Health Care to drop more rapidly than typical market movement.

Factors: The leading Factor Benchmark ETFs are also not particularly organized this week. Risk-on factors are at the top and bottom of the rankings. Momentum and Growth are the top-ranked factors, and High Beta and Small Size are at the bottom. Risk-off factors such as Quality, Yield, and Low Volatility are concentrated in the center of the rankings. However, Momentum typically continues to work as a factor up until the market shifts as a whole, while Small Size has a tendency to lead the market, suggesting caution going forward. As in sectors, the overall momentum ranking for all factors decreased last week, with the average momentum score changing from 11.5 to 5.5. The spread in values decreased from 30 to 29, suggesting the top-ranked factors are slowing and the bottom-ranked factors from the previous week are picking up.

Global: Rankings in the leading Global Benchmark ETFs are also less clear about the sentiment of the market. While Emerging Markets, China, and Latin America are leading the rankings, their momentum scores have also fallen the most for the week. China’s momentum score fell from 54 to 35, while more developed markets such as the US only fell from 12 to 7. The average momentum score globally decreased from 25.8 to 14.9. The US was third from the bottom in terms of absolute rank, but its momentum score fell the least. In developed markets, Canada fell the most, from 18 to 6. Canada is particularly susceptible to changes in commodity prices, particularly oil, which was down for the week.

Two Week Edge Chart 08/16/17

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