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The Problem Of The Stock Market In One Chart

This one chart shows what is wrong now with the U.S. stock market and potentially what can go wrong. A price will be paid but the day of reckoning is delayed.

There is a fundamental problem with this stock market: there is a crowded trade in selected large caps due to risk-off sentiment but the border market grossly underperforms. Below is a table from our weekly premium report with ETF year-to-date performance.

The crowded trade this year is evident from the above table: technology (QQQ) and low volatility S&P 500 (SPLV) significantly outperform small caps (IWM) and high beta S&P 500 (SPHB). At the same time, gold (GLD) is the second choice after technology due to the equity crowded trade. Obviously, some investors think this is not a sustainable market. Note how the high dividend S&P 500 (SPHB) underperforms even bonds (TLT). This is mainly because last year that was a crowded trade.

Below is the chart that shows the problem with this stock market:

The large divergence: low volatility S&P 500 (SPLV) is up 7.55% year-to-date and on an uptrend while high beta S&P 500 (SPHB) is on a mild downtrend yielding less that 1% for the year.

This divergence is a problem because the trade in low volatility large caps is getting crowded. Major holding of SPLV include JNJ, MMM, MCD, KO and of SPHB CHK, MU, FMC and WDC. Note that SPLV is heavily weighted towards utilities and industrials whereas SPHB is more exposed to financials and energy.

For how long investors will continue pumping MCD and KO while also thinking about investing in bitcoin? MCD gained 1.15% last week, now on a 20-week winning streak, the longest since its IPO in the early 1970s. KO surged 3.39% towards 2016 highs. At the same time the utilities ETF (XLU) gained 2.53% and rose to all-time highs.

The conclusion is that risk-off sentiment is prevalent but at the same time the trade in low risk stocks is crowded. This will work as long as central bank officials are willing to openly support equity markets in defiance of free market rules and common sense. If this continues the way it has been instituted and executed, markets may stay on an uptrend but the price that will be paid later will substantially increase. Do not forget that in the last 17 years there were two major bear markets with drawdown in excess of 50%. In the next bear market the drawdown may be worse, even in low risk stocks. But central banks are working hard to delay the inevitable and we must admit they are doing a good job.

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Charting and backtesting program: Amibroker


Technical and quantitative analysis of Dow-30 stocks and 30 popular ETFs is included in our Weekly Premium Report. Market signals for longer-term traders are offered by our premium Market Signals service. Mean-reversion signals for short-term SPY traders are provided in our Mean Reversion report.

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