This is an abridged version of our Daily Report.

Buy-the-dip is dead

Over the past six months, there has been a dramatic decrease in the probability that buyers will step in after weakness. After reaching a 20-year high earlier this year, the probably that investors will buy the drip has dropped below 50% for the first time in two years.

When the probably is above 50%, the S&P’s annualized return since 1928 has been 13.1%. When it’s below 50%, that drops to -1.5%. It’s not necessarily just a feature of bear markets, but stocks generally do better when investors are willing to step in after weakness (of course).

December reversal

The S&P 500 formed a hammer by falling to a new low then reversing by the close. These look nice but have been poor signals in the short-term. A better sign is that stocks have dropped so much in December, which has a strong tendency to reverse in the month ahead, with a 90% win rate since 1950.

Smart money is covering

Large hedgers established a near-record short in equity index futures in September and have been covering ever since. They’re getting close to going net long but have a bit more to go. As of last Tuesday, the latest data available, they were still holding about $2.9 billion worth of contracts net short. If they continue to cover those shorts in the week(s) ahead, we can see from the chart that it’s been a good sign for the broader market.

The latest Commitments of Traders report was released, covering positions through last Tuesday

The 3-Year Min/Max Screen doesn’t show any new extremes. Hedgers have been heavily reducing their longs in 10-year Treasuries but have a long way to go to match where they were at when bonds peaked in June 2016 and September 2017.

This is an abridged version of our Daily Report.

Bonds on sale

A popular intermediate-term corporate bond ETF was trading this week at a price (relatively) far below its underlying value.

Big discounts on liquid ETFs are rare, and often a good contrary indicator. Over its nearly 10-year history, whenever the discount on SPIB exceeded 0.2%, the fund swung to gains within a month every time, and its returns were impressive.

More to sell

Equity hedge funds are still heavily exposed to stocks. After moving to a record high in October, exposure has come down to a neutral level, but it is still well above the zone we’ve seen near past lows over the past decade.

Persistent losers

Securities sinking to a 52-week low have overwhelmed those rising to a 52-week high for months now. A 3-month average of new highs to new lows has dropped so far that it’s now the lowest since the fall of 2008.

Sometimes, an indicator like this can tip us off to deteriorating market conditions that lead to poor returns, like it did in late September/early October. Other times, it can be so bad that it’s good, since the selling pressure has been so heavy and persistent that selling pressure is nearly exhausted.

In this case, it’s more like the latter than the former.

Ugly week

The Russell 2000 fell 2% to a new 52-week low. It has ended a week like this 10 other times.

Out of whack

The Stock/Bond Ratio moved to -2.7 on Friday.

This is an abridged version of our Daily Report.

Regime change

Stocks have swung more than 1.5 standard deviations on more than half the days during the past two months. That’s a big change from September when it happened only once. 

When stocks change from a low-volatility regime to a high one, it has preceded mostly higher prices longer-term. There wasn’t a lot of evidence that the change to a higher level of extreme daily price changes preceded significant changes in the market environment.

More new lows

Even while the S&P 500 is holding above its lows from the past year, many securities have sunk to a lower low, enough so that 52-week lows on the NYSE are the highest in two years.

They accounted for more than 21% of all issues on Thursday. This has been a short-term negative in the past.

Unreliable reversal

The S&P 500 fund, SPY, gapped down more than 1%, lost more than 2% during the day and eclipsed its lowest close over the past six months, but reversed to close almost positive on the day. This looks nice on a chart, but the other 8 times it’s happened, SPY built on its gains only 2 times over the next two weeks. Single-day reversal patterns are notoriously fickle.

Except for small-caps

The IWM fund had a more dramatic reversal, falling below its lowest close of the past year before reversing. Of the 6 other times it’s done so, it continued to rally over the next week all 6 times averaging 3.3%.

This is an abridged version of our Daily Report.

Upside down

The yields on 2- and 3-year Treasuries are now higher than 5-year maturities, an inversion of the short end of the yield curve.

This tends to precede an inversion of the more common 2-year vs 10-year yields. But there has been a long lead time between an inversion on the short end of the curve and a recession, and an even longer lead time before a market peak.

Forward returns in the S&P 500 (and most sectors) were good after the short end inverted. The S&P’s return when the short end inverted for the first time in a year averaged 6.6% over the next two months and was positive 5 out of 6 times.

Vicious selling

The selling pressure on Tuesday was matched only by February 5 of this year. Volume flowing into advancing stocks was below 7% and the Arms Index shows just how skewed that was relative to the percentage of stocks that rose.

Other days with just lopsided pressure saw generally rising prices, especially when excluding 2007. Returns over the next 2-12 weeks were significantly above random, and the risk/reward was skewed positive. Most of the risk over the next year was focused in the first month.

November flow

Traders yanked a significant amount of money from technology-focused ETFs in November, as well as broad-based commodity funds. They were much more positive on health care and emerging market stocks, as well as bond funds.

Jumpy

The VIX jumped 4 points on Tuesday but still closed below 21. That has happened on 14 other days since 1990.

This is an abridged version of our Daily Report.

Partnership pessimism

One of the better ways to gain exposure to master limited partnerships (MLPs) is through closed-end funds (CEFs), which often swing to premiums or discounts to the value of their underlying holdings based almost purely on change in investor sentiment.

The average discount on over a dozen MLP closed-end funds is now large and suggests that investors are showing excessive pessimism toward the sector. It’s not perfect, but it does tend to lead to rebounds.

Wall Street looks to 2019

Strategists surveyed by Bloomberg are estimating a gain of about 9% in the S&P for 2019.

That’s right in line with their usual forecast. Over the past 20 years, their yearly forecast has been wildly off the mark more often than not, so their aggregate estimate for next year should be taken with a grain of salt.

Sentiment and seasonality

The Commodity Sentiment & Seasonality Screen shows that lumber, coffee, and heating oil all having an Optimism Index below 30 while averaging a gain of at least 1% in December. The dollar and natural gas show high optimism and negative average return. The screen for ETFs shows a smattering of country funds with low optimism and good December returns.

New trend?

The S&P just closed above its 50-day average for the first time in more than 30 days and is also above its 200-day average. There have been 7 times this happened in the past 40 years, all leading to gains over the next 3 months, averaging 8.0%. Prior to the last 40 years, it had a mostly negative bias.

This is an abridged version of our Daily Report.

A positive divergence

When the S&P fell to a 6-month low last week, significantly fewer of its individual stocks did so, creating a positive divergence in its Advance/Decline Line.

That looks pretty on a chart, but it hasn’t been consistent enough, and underperformed days when there was no divergence at all.

A better sign is that the S&P surged to its best gain in 7 years following last week’s 6-month low. Longer-term, they tended to be a good sign, with rallies over the next 6 months after 9 of the 11 signals. The only real bull traps, sucking in buyers only to reverse into a protracted decline, were in 1956 and 1974.

Growth worries

A popular aggregate economic model from ECRI is showing a sudden downturn in its growth rate, ending one of the longest streaks in growth mode (or at least not large contractions).

It is very near the average level at the start of other recessions in the past 50 years. By the time it fell to this level, the S&P 500’s future returns were weak, but not quite consistent enough to call it a sell signal.

Cash flow

Mutual fund managers increased their cash level to 3.2% of assets in October, and assets in equity funds fell to 4.7 times the amount in money markets. Both are off their all-time extremes but have a long way to go before even hinting at pessimism.

The latest Commitments of Traders report was released, covering positions through Tuesday

The 3-Year Min/Max Screen shows that “smart money” hedgers moved to only one new multi-year extreme, a long position in Ultra 30-year Treasuries.

This is an abridged version of our Daily Report.

A bottom in jobless claims

After hitting a multi-year low, jobless claims have hit a 6-month high and are above a 52-week average.

That tends to lead to a rise in the unemployment rate, an input to many recession models. But a nascent uptrend in jobless claims has not consistently led to weakness in stocks for at least the next year. Over the next 6-12 months, there was precious little evidence that rising claims exerted a negative influence on stocks.

Margin debt decline

Margin debt plunged in October and is now down year-over-year. After a prolonged rise, the first y/y decline has had a modest record at preceding future weakness in stocks.

Investors’ net worth is also reversing after hitting a record low, but that, too, has a mixed record for stocks. The S&P was weak more than half the time over the next three months, but reward was still higher than risk. It marked the peak of several bull markets but most often, gave false warnings.

Kind of a thrust

Stocks haven’t quite seen a breadth thrust off the low but it got close. After hitting a 6-month low on Friday, Up Volume was more than 70% on Monday and just under 90% on Wednesday. Since 1950, there have been 26 similar signals, leading to modestly positive returns.

See ya

Investors are leaving some of the largest bond ETFs. Shares outstanding in LQD have dropped to the lowest since 2016, and shares in JNK are the lowest since 2011.