This is an abridged version of our Daily Report.

Fading confidence

Preliminary readings on Consumer Confidence were well below economists expected, and showed a large decline from the recent peak.

Fading confidence tends to be more of a negative than positive until it reaches an extreme, and the S&P’s risk was higher than normal when seeing readings like this.

Kick-off breadth

There has been ample evidence since January 4 that we were seeing something different this time in terms of the eagerness of buyers. That has persisted. As a result, over the past month, we’ve seen breadth swing from one extreme to the other, to an extent that has been matched only twice since 1940, and which both kicked off major bull markets.

High yield keeps going higher

Like in the stock market, the high-yield bond market has enjoyed exceptionally broad-based buying. For the past 3 weeks, there has only been one day with more declining bonds than advancing ones, and at least one session when more than a net 40% of the junk bonds advanced.

As much as we can read into a sample size of four, the behavior following these stretches was relatively consistent. Each of them saw the HYG fund pull back over the next 2-4-weeks, and those pullbacks served as excellent staging areas for the next phase of a longer-last rally.

Contracting debt

Margin debt declined in December and is now down 17% from its peak. Cash levels rose, shrinking investors’ negative net worth by about a third. None of these are abnormal given the move in stocks and none are yet extreme in any sense.

This is an abridged version of our Daily Report.

Fibonacci hurdles

The S&P 500 has erased nearly 50% of its October – December decline.

Following a loss of more than 15%, this retracement in only 16 sessions is the 3rd-fastest ever. On average, it took a median of 39 trading days to get to the 50% retracement level, but there was wide variability among them. Only 3 of them managed to do it in less than a month.

It’s not a magical threshold, however, since by the time the rally reached this stage, often buyers were exhausted and returns over the next two months were negative.

Financially sound

The S&P 500 Financial sector has rallied all but one day since the December 24 bottom. Seeing gains in 14 out of the last 15 sessions is a rare feat of buying pressure.

While there is some sense of excessive optimism in the short-term, in the medium-term these kinds of clusters have led to mostly good returns since 1926, especially after the only other time it happened in a downtrend.

Feeling relieved, eh?

The most-loved country at the moment is Canada. Its 10-day Optimism Index is at 80 for one of the few times in the history of the EWC fund. According to the Backtest Engine, this has happened only 3 times when trading below its 200-day average. One preceded a testing of the prior low, while the other two were kick-offs to major bullish moves as the optimistic thrust showed a massive change in character.

This is an abridged version of our Daily Report.

Not buying it

In the three weeks following the December low, leveraged ETF traders have abandoned long funds while flowing into inverse (short) funds, suggesting they’re betting against the rally. When we look at the largest leveraged index ETFs with at least five years of history, we see that since the December 24 low, the long funds have lost a cumulative $501 million. At the same time, leverage inverse funds have seen a cumulative inflow of $523 million. It seems like ETF traders are showing extreme skepticism about this rally.

This is typical behavior, and the past few weeks have been about average for rallies when these traders were not embracing a rally. It led to better shorter-term returns than when they flowed into long funds and out of inverse ones.

Tech first

Out of the “big four” indexes, the Nasdaq Composite was the first to climb above its 50-day moving average. This is considered a good sign of returning risk appetite, but it has been better for future returns when the S&P 500 or DJIA were the first to close above their averages, and worse for forward returns when the Nasdaq or Russell 2000 was the leader.

Challenging

According to the sector ranks later on in this report, Financials are the most-loved sector after Wednesday’s jump. The Optimism Index for the XLF financials fund has soared above 90. According to the Backtest Engine, there have been 47 days when it was above 90 and the fund was below its 200-day average. It added to its gains over the next week 15 times (a 32% win rate).

This is an abridged version of our Daily Report.

The anti-Hindenburg

A compelling reason for caution last fall was the kind of split market that triggered a cluster of Hindenburg Omen warning signs. Over the past two weeks, there has been a cluster of signals that are the exact opposite of the Hindenburg (we'll call them Apollo Prophesies just for the heck of it), and that has usually been a good sign.

After the handful of signals since 1965, the S&P managed to rise every time over the next two months, but a few of those failed over longer time frames.

Rising risk

A model from the NY Fed is showing the highest risk of recession in a decade.

It’s a mild concern, since it has a decent record of preceding recessions since 1960, and returns in stocks once risk got this high were modestly negative. For bonds, it was more of a positive longer-term.

New trend

The Nasdaq Composite is the first of the major averages to regain its 50-day average after going months below it.

Pessimism for volatility

The Optimism Index for VXX has dropped below 15 for the first time since November. According to the Backtest Engine, over the past 5 years when it has done this, the VIX “fear gauge” jumped over the next week 79% of the time and the S&P 500 rose 45% of the time.

This is an abridged version of our Daily Report.

Disappointed

Concerns about an economic or earnings recession have skyrocketed over the last couple of months, and disappointing economic reports worldwide are not helping. Economic surprise indexes across the world are all below zero, and the most negative in two years.

By the time it got this bad over the past 15 years, though, most of the weakness in stocks was already past. Except for late 2007 and arguably again in the fall of 2008, it did not pay to become disappointed along with the economists. It was a little less convincing in other country or emerging market stocks.

Weak leader

The leading economic index from ECRI is showing significant weakness, the most in 6 years. Its record at leading an actual economic recession is mixed when it gets this low - in four cases, a recession had already begun, in two cases, it preceded a recession by at least 10 weeks, giving a nice heads-up, once, the WLIW never got this low before a recession occurred, and twice, it dropped this much and the economy never tipped into recession

Even so, it does tend to precede weaker-than-average stock returns when getting this low. Bonds, on the other hand, have tended to react very well going forward.

Skepticism

The smallest of options traders are still nervous about this market. Last week, they continued to buy a relatively large number of puts, spending 24% of their volume on protective put purchases.

This is an abridged version of our Daily Report.

As good as it can get

Last year, there were no bank failures. That sounds like a good thing, and it’s happened only 3 other times in 85 years. 

A sample size of 3 makes it difficult to consider the precedents, so if we relax the parameters and look for years when there were 3 or fewer bank failures, then we see that stocks did fine afterward, so there was no consistent suggestion that few failures necessarily bred trouble going forward. But returns were less than an any-time, random return across almost all time frames for the S&P 500 and Financials in particular. Returns following years with a high number of failures were much better.

Battle of time frames

More than 90% of S&P 500 stocks are in short-term uptrends, while more than two thirds are still in long-term downtrends.

It is rare to see to this degree, and was a long-term positive. Sectors like Financials, Industrials, and Energy are seeing the same thing, with mostly good returns except for in Energy, which struggled mightily.

Earnings issues?

There have been 16 times when Q4 earnings reporting season began with the S&P 500 below its 200-day average. Of those 16, only 5 managed to rally during the season (about 27 days on average), for a 31% win rate, and an average return of -0.4%.

Slow drift

SPY closed at its highest price in a month on the lowest volume in a month. While below the 200-day average, it added to its gains over the next 3 days 5 out of 15 times, averaging -0.3%.

Reminder: The CoT data is still delayed due to the gov’t shutdown.

This is an abridged version of our Daily Report.

Sentiment cycle

Decades ago, Justin Mamis outlined an ideal Sentiment Cycle from greed to fear and back again. Quite a few cycles since then have adhered closely to the ideal.

According to a Twitter poll by the well-respected Helene Meisler, most people believe we're in the middle part of the Cycle.

If we superimpose the S&P 500 price action from six months before the September peak through now, then it seems clear that we’re in the Panic phase of the decline, suggesting months of digestion ahead.

Ending the correction

The S&P 500 has rallied more than 10% from its low, after falling into a correction. According to some definitions, this means the correction is over. Looking at all corrections since 1928, though, a 10% rally was not a good “all clear” sign, with too many failures over the next few months.

Five in a row

The rally keeps plugging along. SPY is now higher five days in a row, while still being more than 2% below its 200-day average. Over its history, it has done this 11 other times. Its most consistent performance was over the next 7 trading days, when it managed to add to its gains only 1 time (a 0.4% gain in October 2015). Its average return was -1.3%.

Lots of utility

Utilities have struggled a bit, but rallied well on Thursday. Rydex mutual fund traders have piled in, recently putting more than $95 million into that fund. According to the Backtest Engine, that much money led to an average return of -0.7% over the next 3 months.

This is an abridged version of our Daily Report.

Best-ever retracement

Two weeks into a recovery from a major decline, the S&P 500 has made back more than 40% of its losses. If we go back to 1928 and look at every time the S&P declined more than 15% from a multi-year high within a year’s time, then rallied for at least two weeks, we can compare how much of the decline each of them retraced. Out of 29 such attempts, the one we’re seeing right now comes out on top.

Other quick, large retracements led to much better longer-term returns than those rally attempts that were weaker and retraced less of the decline initially. In the next six months following the strongest retracements, the S&P 500 averaged a return of +10.0%. After the weakest, it averaged a lowly -5.4%. 

Sigh of relief

The VIX “fear gauge” has dropped dramatically as options traders price in a much reduced level of volatility going forward. But the S&P 500’s actual volatility remains high.

The spread between the two is now among the widest since 1990, and other times it got this wide, stocks mostly struggled going forward.

Four in a row

The S&P 500 fund, SPY, has rallied four days in a row while below its 200-day average, with today’s gain being the smallest of the four. That has led to more gains over the next three days only 3 out of 11 times, averaging -1.3%.

Wow

This is just further confirmation from other thrusts we've shown in the past few days, but the 10-day average of Up Volume has now reached 70%. According to the Backtest Engine, there have been 46 days since 1962 when it was this high. A year later, the S&P 500 was higher 43 times.