by Timothy D. Carkin, CAIA, CMTSenior Equity Trader
With the partial shutdown of the government behind us, the equity markets have been on a near constant rise seemingly setting new highs daily. “Kicking the can down the road” gave investors the excuse to jump back into the markets as evidenced by the S&P 500’s 100-point gain since October 9. As the market ran up, Chicago Board Operative Exchange Volatility Index (VIX) was dropping. This is positive – it signals investors’ acceptance of the continued market highs. Looking further into the equity markets we see confirmation of the rally with industrial, healthcare, and consumer discretionary sectors setting new highs. Not surprisingly, almost 70 percent of the Dow Transportation Index are within 3 percent of their 52-week high. Strength in these sectors, coupled with an increase in volume, and a reduction in volatility is a recipe for a continuation of the bull market.
The market’s reaction to Microsoft’s earnings this morning, opening up more than 6 percent, was supportive of a bullish rally. In a typical market rally, quality stocks lead the market up. As the proverbial rising tide lifts all boats, the lower quality stocks rally as well. As the market exhausts, investors seek out newer opportunities and start to buy up those riskier, lower quality stocks, eventually driving valuations to excess leading the market to correct. Continued leadership of other bellwethers like Boeing, Verizon, Nike and American Express is a good sign of the health of this rally.
With all that said, one simple truth is that the market does not go straight up. Most equity markets can handle a loss of a few percent without losing their bullish momentum. As you can see in the chart below, we are at the upper bounds of the market channel. Trading down to the trendline would be perfectly normal and still maintain the trend. However, if that pullback is preceded by higher volatility or rallying lower quality stocks, this might indicate a more significant pullback.
Our Takeaways from the Week
- Market momentum is strong, even at market highs
- As the rally continues, watch for signs of stress