Mr G.Scott Cmt
Monday, February 10, 2020
1. Stocks hit new highs as investors reflect on earnings reports
2. Profit-taking behavior strongly likely soon
3. Balance after a buying binge
The major market indexes jumped strongly today with the Nasdaq 100 (NDX) and the S&P 500 (SPX) rising to new highs. Stocks drove higher despite the news that Coronavirus headlines proclaimed a surge in both case counts and death toll. Investors instead focused on the generally better-than-expected news during the past three weeks of earnings reports.
The Dow Jones Industrial Average (DJX) rose also. However, it failed to reach its previous highs. The Russell 2000 Small Cap Index (RUT) and the Russell Microcap Index (RUMIC), both significantly lower than their 2020 highs, lagged behind the other indexes for percentage gains today. The fact that these indexes are showing weakness during an otherwise strong upward move gives rise to some analysts speculating that the market may be drastically overbought while sitting at resistance. This could spell the conditions for a significant market correction.
The chart below demonstrates that even though stocks have had a strong run and have met with recent volatility, that there still could be room for them to rise higher at least for a little while longer. The chart displays a weekly reading of the percentage of the thirty stocks in the Dow that are trading above their 20-day moving average (green line), 50-day moving average (yellow line) and 200-day moving average (red line). The blue shaded areas correspond with the red arrows on the index price line below the chart.
This measure of market breadth turns out to be significant historically. When all three lines climb above the 80% level simultaneously, it makes for a highly predictable environment for a pullback in prices. What is most interesting about the chart is that, right now, the indexes are nowhere near that condition.
Profit-Taking Behavior Strongly Likely Soon
Despite the positive outlook investors have right now, there may be a time in the near future when prices will pullback, and possibly tumble precipitously similar to the way they did late in 2018. That's because high-net worth investors tend to watch the calendar. Long-term capital gains tax rates are sufficiently lower than the tax rates for ordinary income that investors would prefer not to be taxed at the latter rate. That gives incentive for them to hold on to stocks for at least one year's time.
The effect of this incentive on the market indexes is demonstrably negative one year after any period in which the S&P 500 index rises more than seven percent in one month. Given that January 2019 featured a 14.5 percent increase, it becomes highly likely that those investors who bought into the market that time will begin to consider taking profits. If enough of them do so at the same time, an otherwise inexplicable pullback in prices may occur