U.S. stocks are making a broad advance, seemingly ignoring the fundamental impacts of government sequestration and the technical significance of multi-year overhead resistance. Last Friday, President Obama signed the order to begin the government spendings cuts known as sequestration. Unlike all the previous deadlines, there was not any last minute action to postpone the inevitable. Perhaps that is what is spurring the markets higher – the fact that our elected officials allowed a step toward deficit reduction occur.
Many analysts are now stepping forward to claim the economic recovery is stronger than previously thought and has enough momentum to overcome the harmful effects of the budget cuts. Along those lines, the negative initial fourth quarter GDP report of -0.1% has now been revised to +0.1%. However, the Congressional Budget Office estimates that sequestration will reduce GDP by 0.6% this year.
Unless you’ve been away from the financial media the past few days, then you are probably aware the Dow Jones Industrial Average is now at a new all-time high. Its prior peak was established more than five years ago on October 9, 2007. Its bear-market bottom on March 9, 2009 represented a 53.8% plunge requiring a 116% gain to get back to its 2007 level. Investors need to keep in mind that although it has been more than five years since a new high has been established, it is actually a quite common event. The Dow has advanced from around 66 to nearly 14,300 over the past 112 years. The number of all time new highs along the way has been significant.
Of more interest is what it means for the future, and once again there are different views. Many are convinced the bull is tired after its long four-year climb. They argue the Dow is in the process of forming a multi-year double top. Supporting evidence is supplied by the S&P 500, which is still a percentage point or two from a new high and looks as though it could be forming a triple top stretching back to 2000. This group throws in all the economic worries for good measure.
The bullish case has a large number of proponents as well. From a sentiment perspective, they like to point out that new highs in the Dow tend to bring retail investors back into the market. Technically, a new high signals a breakout and the start of a new upleg. For fundamental support, they like to point out that stocks are cheap relative to other asset classes. For now, the trend is up, and the bullish view is in control.
Pattern traders will probably note the ‘Machete with a Handle’ pattern that the Sector Edge rankings are producing today. Okay, that’s a name we just made up, although it is a fairly accurate description of what is occurring. The ‘blade’ portion of the pattern consists of a near six-way tie. These are the leaders, blazing the market trail. The fact that there are so many indicates the current advance is very broad. The sectors represented in this top six are an interesting, if not unusual, mix. Cyclically sensitive groups of Industrials, Financials, and Consumer Discretionary are sharing space with the defensive Health Care, Consumer Staples, and Utilities sectors. Eventually, a recognizable leader will evolve, but until then, the position is up for grabs. The ‘handle’ portion of the pattern, the area furthest from the action, consists of the same laggards as last week, namely Telecom, Technology, and Materials.
We don’t have a cute name for the pattern visible in the Style Edge rankings today, although we do have an interpretation. Similar to the sector rankings, the large contingent of styles vying for the leadership role indicate a broad market advance is underway. Under these conditions, participation is much more important than security selection. A closer inspection of the rankings reveals that the major themes have not changed: Value is preferred over Growth, and Mid and Small Cap stocks are preferred over Large Caps. The lagging nature of the Large Cap groups indicates investors have an increasing appetite for risk. Mid Cap Value remains atop the stack while Mega Cap replaced Large Cap Growth on the bottom.
The Global Edge rankings stand in stark contrast to the other two. Here, there is clear leadership, regions not participating in the market rally, and the laggards actually in downtrends. Japan takes top honors again this week. As a reminder, the momentum measurements of the foreign regions in these rankings include the underlying currency impacts, not just the stock market action. In the case of Japan, its stock market has been very strong and the yen has been declining. If the currency effects were eliminated, the leadership of Japanese stocks would be even more pronounced. There are arguments on both sides of a country’s desire to have a weak versus strong currency. The primary argument in favor of a weaker currency is it makes that country’s exports more competitive in the global marketplace. That is one of the driving factors of Japan’s desire for a weaker yen at this time. There is always friction when a country takes deliberate action to influence the value of its currency. Japan’s aggressive action is not being viewed favorably by China, which happens to be at the other extreme in our rankings today. Japan’s deliberate devaluation of the yen is tantamount to using its neighbor as “garbage bins” according to the president of China’s sovereign-wealth fund.