Like a magician who uses misdirection to distract the audience from what really matters, the possibility of a government shutdown—still to be determined as of press time—took investors’ attention away from the slow rise in Treasury yields.

That’s too bad, because the latter might ultimately matter more for the stock market than the former.

Not that you’d know anything serious happened last week simply by looking at the benchmark returns. The Dow Jones Industrial Average gained 268.53 points, or 1.04%, to 26,071.72—just another all-time high—while the Standard & Poor’s 500 index rose 0.9%, to a record 2810.30. And the Nasdaq Composite climbed 1%, to 7336.38, also an all-time high. The S&P 500 has now closed at a record level 10 times this month, just one short of the record of 11 set in January 1964—with eight trading days to go.

Do you know what else rose to a new high, though not a record one? The 10-year Treasury yield, which closed at 2.639% Friday, its highest since July 2014. The stock market didn’t mind—obviously—and there are many who believe that yields can just keep heading higher without dinging equities, as long as increases are driven by growth and inflation. Others contend that it’s the speed of the move that will determine whether stocks rise or fall, if the 10-year yield does indeed break higher. “The market doesn’t like quick moves,” says Quincy Krosby, chief market strategist at Prudential Financial. “That gives it the jitters.”

Not everyone is so sure. Jim Paulsen, Leuthold Group’s chief investment strategist, notes that bond yields have been trending lower for the past 38 years, and have remained within one standard deviation—a measure of the dispersion of readings from the average—for 72% of that time. Why is this important? The 10-year’s 2.64% yield is now above the current one-standard-deviation mark of around 2.44%, he says. That’s occurred just 12.6% of the time since 1980, but when it did, equity returns were markedly lower than when yields were in the range: The S&P 500 has advanced an average of 2.7% during the 12 months following such an instance, versus an average of more than 10% when yields remain contained within the bands. “The perception of normal rates has come down so much that it might not take a lot to hurt stocks a bit,” Paulsen says.

David Ader, chief macro strategist at Informa Financial Intelligence, takes it a step further: He wonders if you can be bearish on Treasuries—bond prices fall as yields rise—and still be bullish on stocks. He notes that the difference between the 10-year yield and the S&P 500’s dividend yield has widened to about 0.6 of a percentage point in favor of Treasuries. The wider that gap grows, the more enticing bonds will become to investors who still need yield. “My target is 2.85% to 3%,” Ader says. “If we reach that, the equity market will go the other way.”

(Source: Barrons Online)

The perfect year is over, even if it ended on a note of imperfection.

The Dow Jones Industrial Average fell 34.84 points, or 0.1%, to 24,719.22 last week, not big deal. But the Standard & Poor’s 500 index fell 0.4%, to 2673.61, and the Nasdaq Composite dropped 0.8%, to 6903.39, their largest weekly declines since Sept. 8.

Despite ending on a sour note, it’s hard to argue that the year could have gone much better. The Nasdaq finished up 28% in 2017, while the Dow gained 25%, and the S&P 500 rose 19%. And the S&P 500 even managed to finish in positive territory each month on a total return basis—the first time that has ever happened. “You don’t get an easier year than that,” says Michael Shaoul, CEO of Marketfield Asset Management. As we said: perfect.

Following perfection is rarely easy, though the market has been pretty good at responding to big gains with more of the same. Including reinvested dividends, the S&P 500 has returned 20% or more 26 times since 1943, and followed that up with another positive year 20 times, says Sadoff Investment Management. The average return following a 20% gain has been 12%. But four of the six down years—1962, 1981, 1990, and 2000—had one thing in common: The Federal Reserve was “dramatically tightening credit,” Sadoff says.

While no one would describe the Fed’s current tightening as “dramatic,” it has been raising interest rates and would like to raise them a few times more next year. The market isn’t buying it yet, especially as inflation remains so low. But some assets are close to levels that may force investors to rethink their expectations, says Jim Paulsen, Leuthold Group chief investment strategist. He notes that the U.S. Dollar Index is approaching a three-year low—it closed down 9.7% in 2017 after declining 1.1% last week—while the 10-year Treasury yield closed the year at 2.41%, just 0.2 percentage point away from a three-year high of its own.

Even oil managed to close the year at its highest level in 2½ years. If they all break out, especially if they do so simultaneously, more inflation could be building than the market expects, and that would force investors to reconsider whether they want to pay 18 times forward earnings for the S&P 500, Paulsen says. “This year felt like a sweet spot,” he continues. “The question is whether that sweet spot can persist.”

What should we hope for? Not another 2017, says Jason Pride, director of investment strategy at Glenmede. With valuations as high as they are, another year of big gains could stretch them even more, even to levels that trigger a selloff. “We’d prefer to see 2018 be tamer for the market,” he says.

As if we have a choice in the matter.

It wasn’t as if there was no news to get the market moving. We learned last Friday that new-home sales had surged in November, and that consumers are spending more and saving less. Congress passed its tax bill, which was then signed into law by President Donald Trump, and it also agreed on a stop-gap budget measure to keep the government funded through the middle of January.

Who could ask for anything more?  The market, it seems. The Dow Jones Industrial Average gained 102.32 points, or 0.4%, to 24,754.06 last week, while the Standard & Poor’s 500 index advanced 0.3%, to 2683.34, and the Nasdaq Composite rose 0.3%, to 6959.96. It was something of a yawn, and trading even reflected it: Friday’s volume was the lowest for a full day this year.

Most of the easy money has already been made in the tax trade. When it became clear in mid-November that getting tax cuts passed by Christmas had become a real possibility, the S&P 500 rallied 4.6%. Stocks set to get a big earnings boost outperformed the overall market. “Much—but not all—of the tax-related benefits to earnings are likely reflected in stock prices already,” explains Credit Suisse strategist Jonathan Golub. He isn’t worried, however, because he believes earnings growth and higher valuations can push the S&P 500 up to his year-end target of 3,000.

Maybe so. But there’s no denying that everything is about to get a lot more complicated—including those earnings. Until last week, analysts had been reluctant to change their estimates to account for tax cuts because they didn’t know what a final bill would look like. Now they do, so they are tweaking their numbers, even if much of what we know at this point is still guesswork.

That could make for more turbulence during the first part of the year, as investors wait to see what the real impact of tax reform is, says JJ Kinahan, chief market strategist at TD Ameritrade. “I don’t know if the market will react as positively to the first couple quarters of earnings because people will be adjusting to what they mean,” he says.

And that’s not the only adjustment we’ll have to make. We’ve been on the lookout for signs of excess—a boom in mergers and acquisitions, a spike in capital spending—as a possible indicator that the market was peaking. But it’s the excesses that are fading away that could create the real problems in 2018, says Leuthold Group Chief Investment Officer Doug Ramsey.

One is the economy’s excess capacity, which, Ramsey notes, has closed, according to Congressional Budget Office estimates. That means there’s less potential for economic growth. The Federal Reserve’s quantitative-easing program also created excess liquidity in the market, with all the extra cash likely going into financial assets. But liquidity—as measured by growth in the money supply minus growth in industrial production—has also started to dry up recently, according to Ramsey. “The landscape is changing under our feet,” he says.

None of this points to an imminent end to the bull market. But it suggests that next year may be no holiday.

(Source: Barrons Online)

It’s the most wonderful time of the year, or so the song goes. And while those who hate the snow might disagree, for the stock market, December really can be wonderful.

For a moment there, though, it didn’t feel that way. The Standard & Poor’s 500 index started the week where it had left off the previous one—with a small decline—and just kept on dipping. By Wednesday, it had dropped four days in a row. But as Nomura Instinet technical analyst Frank Cappelleri noted, the benchmark hadn’t dropped for five or more days in a row since November 2016, and it wasn’t about to suffer one now. The market rallied for the rest of the week.

All told, the S&P 500 advanced 0.4% to 2651.50 last week, an all-time high, while the Dow Jones Industrial Average rose 97.57 points, or 0.4%, to 24,329.16, also a record. The Nasdaq Composite finished down, but only just: It declined 0.1%, to 6840.08.

If I were a betting man, I’d place my wager on more gains from here. During the past 20 years, just five Decembers have finished in negative territory, for an average loss of 1.8%, a number exacerbated by a 6% tumble in 2002. The rest of the time, December has delivered gains—often quite good ones: The average December rise has been 2.6%.

Enjoy This Market While It Lasts

The odds of a big spike in volatility are even lower. Nicholas Colas, co-founder of DataTrek Research, notes that since 1990, the CBOE Volatility Index, or VIX, has tended to peak in January, August, or October, while its troughs have occurred most often in July or December. This year, the VIX hit its low of 9.1 in November, a month that has rarely marked the bottom for the measure. The upshot: “Markets are much more likely to resemble Santa than Scrooge during the holiday season,” Colas says. For the record, the VIX closed at 9.58 on Friday.

There’s not much to scare the market between now and year end. Congress has extended the budget deadline until Dec. 22, avoiding a government shutdown, and if they can do it once, they can probably do it again. Tax reform is making progress, and there’s even a chance that a bill reaches President Donald Trump’s desk for signing by Christmas. And it’s not as if the market needs tax reform to keep chugging along. As we saw on Friday, U.S. payrolls are still growing at a healthy clip—the economy added 228,000 new jobs in November—while the unemployment rate remained at 4.1%.

MKM Partners strategist Michael Darda calls it the best-case scenario for markets. “Growth momentum remains above recovery averages, but not so fast as to create an inflation panic at the Fed,” he explains. “Enjoy it while it lasts.”

(Source: Barrons Online)

It was the melt-up that wasn’t. And that’s probably good news for investors.

Last week, the major indexes were well on their way to new highs—the Dow Jones Industrial Average had gained more than 700 points through Thursday’s close—thanks to solid Thanksgiving shopping reports from retailers and progress on tax reform.

Headlines hit the newswires reporting that Michael Flynn, a former advisor to President Donald Trump, had agreed to plead guilty and testify, causing the Dow to shed 400 points from peak to trough in a matter of minutes. The drop happened so quickly that some opined that humans couldn’t have been responsible for the tumble. “No way real traders were moving that fast,” says Andrew Brenner, head of international fixed income securities at NatAlliance Securities. “Clearly, it was algorithms taking over.”

Not for long, however. The Dow rallied back and finished off just 40.76 points on Friday, ending the week, if not on a high note, then with a sigh of relief. The Dow industrials gained 673.60 points, or 2.9%, to close at 24,231.59—their largest weekly gain since December 2016. The Standard & Poor’s 500 index rose 1.5%, to 2642.22. Only the Nasdaq Composite finished lower: It dropped 0.6%, to 6847.59.

Yes, the Nasdaq, home to some of the year’s best-performing stocks, finished down on the week, as clear a sign of a market rotation as we’re likely to see. The seven top-performing stocks, including L Brands (ticker: LB) and Discovery Communications (DISCA), had all suffered double-digit declines this year, while the nine worst-performing stocks, including Micron Technology (MU) and Nvidia (NVDA), all had double-digit gains. That rotation might have exacerbated Friday’s selloff, says James Paulsen, chief investment strategist at the Leuthold Group. He contends that the move from one sector to another likely made the market more susceptible to some sort of surprise. “It could have been any news,” he explains. “If the rotation hadn’t been happening, it might not have mattered.”

But the rotation is happening. JPMorgan strategist Shawn Quigg attributes the shift from highflying growth stocks to beaten-down value plays to the increasing odds that tax reform will pass, as investors begin to shift money into the companies that will benefit if taxes are cut. If that’s the case, investors have two choices—either to put new money into what had been the market’s laggards, in which the former highfliers could lag but still rise with the market, or reduce their exposure to the former winners like Facebook (FB), Wynn Resorts (WYNN), and Netflix (NFLX) and put that cash to work elsewhere. Quigg leans toward the former, but notes that either way, investors should be more careful with their winners. “There’s some added risk into year-end,” Quigg says.

But Friday’s Flynn-inspired selloff that wasn’t can also be chalked up as just one more test for this bull market that began more than eight years ago. We’ve had selloffs related to Brexit, weakness in China’s yuan, and numerous others along the way. And yet the market keeps ticking higher. If you weren’t watching closely Friday, you might not have even noticed that anything exciting was happening.

It also pays to remember that politics doesn’t usually derail a bull market—it certainly didn’t during the Bill Clinton impeachment, says Krishna Memani, chief investment officer at OppenheimerFunds. And with the melt-up postponed, stocks are set to continue what has been a slow plod higher. “We’re in a good situation,” he adds. “We should fret less and enjoy it more.”

(Source: Barrons Online)

If the market were a watch, we would say it could take a licking and keep on ticking. If it were a prizefighter, we’d say it knew how to ride a punch. But it’s a market, and that simply means investors are willing to take chances again and again and buy the dips.

You wouldn’t know it by looking at the major indexes, which finished mixed on the week. The Dow Jones Industrial Average dropped 63.97 points, or 0.3%, to 23,358.24 last week, while the Standard & Poor’s 500 index dipped 0.1% to 2578.85. The Nasdaq Composite rose 0.5% to 6782.79.

The Market’s Journey: Don’t Stop Believing

The final tally, however, doesn’t do justice to the beatings the market took at the open early in the week. The Dow traded down nearly 80 points on Monday, 170 points on Tuesday, and 170 points on Wednesday, but each time the blue-chip benchmark finished off its lows. That was followed by the Dow’s 187-point rally on Thursday, as everyone bought the dips. “We saw a bit of a shakeout,” says Todd Lowenstein, director of research at HighMark Capital Management. “But the market has been resilient.”

Has it ever. The S&P 500 has now gone 62 weeks without a drop of 2% or more, the longest such streak since 1965. And it isn’t as if there haven’t been reasons to sell, from the narrowing difference between short-term and longer-term Treasuries—known as a flattening yield curve—to tax-reform hiccups in Washington and a selloff in high-yield bonds that briefly caused investors to wonder if the credit market was acting as an early warning signal.

They needn’t have worried. See, it isn’t just equity investors who are looking to turn selloffs into buying opportunities. The iShares iBoxx $ High Yield Corporate Bond exchange-traded fund (ticker: HYG)—a reasonable facsimile of the overall junk-bond market—rose 0.4% last week after dropping 1% the week before. Despite the fact that equity investors were watching junk bonds, junk-bond investors were—you guessed it—buying the credit dip. “That will have to change before the ‘HYG leading stocks story’ becomes a truly lethal one,” says Nomura Instinet technical analyst Frank Cappelleri.

The truly scary thought is that even volatility can’t seem to kill the speculative bug. What if higher volatility, instead of scaring investors away from the stock market, brings them in? In that case, this bull market could still have a long way to go.

(Source: Barrons Online)

If, as the proverb suggests, people who expect nothing are blessed because they’re never disappointed, then most of us were left hurling curses at the market last week.

The bulls, because the major indexes couldn’t build on previous gains. Anyone hoping for a quick and easy path to tax reform, thanks to conflicting Senate and House plans. And even the bears, for the market’s failure to tumble despite the ample opportunity.

And what an opportunity it was. Last Thursday, the Standard & Poor’s 500 index dropped as much as 1.1%, but battled back to finish down just 0.4%. Instead of ending the benchmark’s streak without a 0.5% decline or more, it extended it to 47 days, the longest streak since 1965.

All told, the S&P 500 declined 0.2% to 2582.30 last week, while the Nasdaq Composite dipped 0.2% to 6750.94. The Dow Jones Industrial Average dropped 116.98 points, or 0.5%, to 23,422.21.

Of course, there are plenty more opportunities for disappointment to come. Tensions in the Middle East could continue to rise. Economic data this coming week will have latest inflation readings. Earnings from retail bellwethers like Wal-Mart Stores (ticker: WMT) and Home Depot (HD) are due. And, of course, the ongoing tax saga could continue to swing the market, in what Bank of America Merrill Lynch describes as “tax reform on, tax reform off.”

Even the conventional risk on/risk off trading pattern wasn’t what you would have expected last week. Normally, when stocks and other risky assets decline, bond yields fall and prices, which move in the opposite direction, rise, as investors seek a haven from the selling. And there were plenty of reasons to seek safety last week, including the continued turmoil in Saudi Arabia and fears of a bigger war in the Middle East, notes Steven Englander, head of research and strategy at Rafiki Capital Management.

But there are also plenty of reasons to worry that the Federal Reserve will continue to raise interest rates, which would explain the 0.064-percentage-point increase in the 10-year Treasury yield on Friday, the largest since September. “The up move in bond yields looks like fears that the tightening cycle is beginning, but it’s not really consistent with regional war and oil price concerns,” Englander says.

But who needs consistency, anyway? Remember, the stock market just finished one of the least volatile Octobers on record, while September, rather than living up to its reputation for tepid returns, produced a 1.9% gain for the S&P 500. So would it be any surprise if November—usually one of the strongest months of the year—falls well short of bullish expectations? Hedge funds, says Wellington Shields technical analyst Frank Gretz, appear to have loaded up on stocks to take advantage of the 11th month’s reputation for stellar gains, something he calls worrisome. “Talk is one thing,” Gretz says. “The worry part is if everyone acts on this positive seasonality.”

(Source: Barrons Online)

The stock market, by all appearances, has become a perpetual motion machine that won’t even let a controversial tax plan or a change atop of the Federal Reserve derail its momentum.

And what momentum it is. The Dow Jones Industrial Average rose 105 points, or 0.4%, to 23,539.19, last week, while the Standard & Poor’s 500 index advanced 0.3%, to 2587.84. The Nasdaq Composite gained 0.9%, to 6764.44. All three benchmarks closed at record highs.

We know the headlines have all been about the Republican tax plan—which may help some stocks and hurt others—and the appointment of Jerome Powell to replace Janet Yellen as Fed chair. But the real story is that the best-performing stocks keep dragging the major indexes higher, meaning that this truly is a momentum-driven market.

On the Street, momentum is the strategy of buying the market’s best-performing stocks and ignoring all the rest. It’s been a winner this year, as highfliers like Boeing (ticker: BA), HP (HPQ), and MasterCard (MA) have helped it outperform. The MSCI USA Momentum Index returned 33.9% through the end of October, outpacing the MSCI USA Index’s 17% return. That 16.9-point performance gap is the best for a full year since 1999, when momentum outperformed by 17.2 points.

“It’s been an amazing run of outperformance,” says Oppenheimer technical analyst Ari Wald.

But has the gap between the performances of the two indexes grown too big? MKM Partners technical analyst Jonathan Krinsky compared how big that gap is relative to its 200-day average, and found it’s at a level that often signals a peak in momentum. Sometimes it’s simply a pause—that was the case in 2005—but sometimes it can signal an impending peak, as it did in 2008. “Momentum names are stretched relative to the market,” Krinsky says. “But they can become more stretched.”

The question is how much more. Andrew Slimmon, a portfolio manager at Morgan Stanley Investment Management, notes we’re at that time of year when investors ride their winners and dump their losers for tax-loss purposes. And this year, the inclination to hold winners might be even stronger than in the past, thanks to the Republican’s tax-reform plan—and the off chance that capital-gains taxes—left untouched so far—head lower in the final version. “Momentum works at this point in the year,” Slimmon says. “And it’s accentuated by the change in tax policy.” That suggests at least another month of outperformance.

But that seasonal boost is followed by the so-called January Effect, the name given to the period when investors finally take profits in the market’s winners. It used to happen in January—hence the name—but has moved to mid-December as market participants responded to the anomaly by selling even earlier. This year, it happens to coincide with Congress’ holiday recess, but also with the Federal Open Market Committee meeting on Dec. 12 and 13. Don’t be surprised if momentum hits a brick wall around that time. “We could see a reversal just as everyone wants to go on holiday,” Slimmon says.

But at least we’ll make merry until then.

(Source: Barrons Online)

For the last three months, titans like Amazon.com, Alphabet, and Facebook have quietly lagged the market as investors bet on old-economy stocks like General Motors, Michael Kors Holdings, and Bank of America, all of which had double-digit gains during the same period.

Then last Friday happened. Stellar earnings from Amazon (ticker: AMZN), Alphabet (GOOGL), and Microsoft (MSFT) sent those stocks up 13%, 4.3%, and 6.4%, respectively. And just like that, tech is hot again. How hot? The Nasdaq Composite gained 2.2% on Friday, 2.06 percentage points more than the Dow Jones Industrial Average’s 0.14% advance, the widest single-day gap between the two benchmarks since 2002. The Standard & Poor’s 500 index rose 0.81% to 2581.07. Both the Nasdaq and the S&P 500 closed the week at new all-time highs.

The question is whether investors will wake up next week with a big tech hangover. Much will depend on earnings from Facebook (FB), which is set to report on Wednesday, and Apple (AAPL), scheduled for Thursday. But the situation isn’t all that different from tech’s June underperformance—the Nasdaq declined 0.9% that month–which was followed by a July rally, says Frank Cappelleri, a technical analyst at Nomura Instinet. And if financials, which have gained 3.5% in October, continue to rally, even after dipping 0.2% on Friday, you could have a recipe for an accelerating market with tech in the mix. “If people want melt-up potential, that narrative has a good chance of creating it,” Cappelleri says.

Unless one has already occurred. That’s a theory floated by INTL FCStone Financial strategist Vincent Deluard—based on the market’s low volatility. The Dow has returned 32% during the past 12 months, a great return, though there have been better. But the Dow’s realized volatility during that period has been around 7%, which would put its Sharpe ratio—a measure of an asset’s return relative to its volatility—at around 4.6. To put that in context, Deluard notes that in normal times, any hedge fund would be happy to deliver a Sharpe ratio that’s half of that. Another way to look at it is to consider what the Dow would have to return to maintain that Sharpe ratio if volatility returned to its average of 16% going back to 1900. The answer: More than 70%. “By any standard, a melt-up has already happened,” Deluard says.

And it is strange how quiet the market is. October, remember, is supposed to be the market’s most volatile month. Through Thursday, however, it was the least volatile October on record going back to 1928, according to Ben Bowler, global head of equity derivatives research at Bank of America Merrill Lynch. He chalks that up to the fact that the market assumes that the world’s central banks will backstop it no matter what, making every drop a buying opportunity. Bowler foresees two factors that might change that outlook in the U.S. One would be higher inflation, which could force the Federal Reserve to take a more hawkish stance. The second would be a new Fed chief—and that chairman’s outlook on the moral hazard created by central bank puts. “We need to break this psychology that shocks are good because it means an opportunity to buy the dip again,” Bowler says.

If tech stocks keep running, that might be easier said than done.

(Source: Barrons Online)

A week that could have been a nightmare instead finished like a dream.

The Dow Jones Industrial Average climbed 456.91 points, or 2%, to 23,328.63 last week, while the Standard & Poor’s 500 index rose 0.9% to 2575.21. The Nasdaq Composite advanced 0.4% to 6629.05.

For a while there, though, it looked like it could go either way. On Thursday—the 30th anniversary of Black Monday—the Dow briefly traded down more than 100 points, raising concerns of a repeat. But the market rallied back to close at a new high, and the decline became just the latest example of investors buying the dip.

It wasn’t just the market that saw dip-buying. Shares of General Electric tumbled 6.3% in early trading on Friday after the industrial giant slashed its full-year profit guidance. Investors, betting that the worst was over, pounced, and GE’s shares finished up 1.1% on the day. “It’s another microcosm of buy-the-dip,” says Scott Clemons, chief investment strategist for private wealth management at Brown Brothers Harriman.

For investors, there’s little evidence to suggest dips in the market shouldn’t be bought. Earnings have been solid.  How those earnings and sales continue to play out could go a long way toward determining whether the market can continue its long trek higher, especially with tech giants like Amazon.com (AMZN) and Alphabet (GOOGL) reporting on Thursday. “If tech continues in a great way, the market can head higher,” says JJ Kinahan, chief market strategist at TD Ameritrade.

Still, it took more than earnings to push the market higher last week. On Thursday night, Senate Republicans agreed to a budget framework that could allow a tax package to pass with only a majority of votes, rather than a filibuster-proof 60. That helped the Dow gain 165.59 points, or 0.7%, on Friday.

“We still say the line to tax cuts won’t be a straight one,” Michael Block, chief strategist at Rhino Trading Partners, wrote in a note to clients last week. “Optimism that this gets done quickly and without controversy is bubbling.”

But not too much optimism, as the market still refuses to get too excited by anything. The Dow, in fact, hasn’t gained more than 1% on any single day since Sept. 11, and yet it’s managed to hit 53 new highs this year, the most since 1995. “It’s the market equivalent of three yards and a cloud of dust,” says Brown Brothers’ Clemons. “It’s just one slow grind upward.”

(Source: Barrons Online)