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Expected Weak Q2 Likely a Buying Opportunity!

  • Written by Syndicated Publisher No Comments Comments
    April 9, 2013

    It appears we are in the process of starting the first correction of the year; but, given recession risks remain a remote possibility and the long-term internals of the market remain sound, any correction in Q2 will likely prove to be a buying opportunity. A quick summary of the state of the economy and markets is provided below.

    Economy Looks Solid

    Philly Fed’s State Coincident Diffusion Index (Net % of states growing) is shown below in red along with the S&P 500 in black. Basically as long as it stays above 0%, recession risk is minimal and pullbacks are typically followed by new highs in the market.

    philly fed
    Source: Bloomberg

    Here, we see the S&P 500 shown alongside initial jobless claims (inverted for directional similarity). Jobless claims confirmed the new high in the market by hitting a new low. This is significant as jobless claims usually diverge at major peaks with the market.

    jobless claims
    Source: Bloomberg

    Corporate Bond Market Showing Stress, Not Yet Present in Stock Market

    Chart below shows high yield bond prices with the S&P 500. High yield bond prices typically peak before the market (see yellow boxes below). Last week they spiked down, which suggests a pullback.

    high yield
    Source: Bloomberg

    Indicators Suggesting Q2 Correction

    Next chart shows the relative performance of early to late-stage cyclicals, which typically leads the market by 6-9 months. Current data suggests we see a correction beginning this month and lasting through May (see blue box below).

    cyclicals
    Source: Bloomberg

    The chart below shows oil prices (red line) advanced and inverted relative to the S&P 500’s price appreciation (blue) and the Citigroup Economic Surprise Index (black line) for major economies. Past spikes in oil suggest rising inflation should spill over into the economy slowing growth and corporate earnings. Consequently, the stock market may disappoint between April 12th and May 31st.

    oil
    Source: Bloomberg

    Weakening Breadth and Momentum

    Below is a chart of the S&P 500 and various breadth measures of the 500 stocks within the index which are showing negative divergences with the price action in the S&P 500, which typically occurs prior to a pullback.

    • 2nd Panel – Shows % of members above moving averages
      • % Above 20d SMA diverging and falling sharply as it did prior to last two pullbacks
      • % Above 50d SMA also diverging with price, showing signs of selectivity
    • 3rd Panel – Members with RSI above 70 or below 30
      • % of stocks with strong momentum ( > 70) fading as it did prior to November 2012 correction
    • 4th Panel – Members hitting 3-month new highs/lows
      • % of stocks hitting 3-month new highs diverging with price.
    • 6th Panel – % Members with MACD above 0
      • Not yet below 70% which often markets intermediate sell signals but is diverging with price

    breadth
    Source: Bloomberg

    Summary

    While several leading indicators and weakening market breadth suggests that we could have a pullback in Q2, given the state of the economy and long-term technicals of the market remain healthy, any correction that develops is likely to be a buying opportunity.

     

    Image: Flickr (licence attibution)

    About The Author – Chris Puplava, Financial Sense Online

    Chris graduated magna cum laude with a B.S. in Biochemistry from California Polytechnic State University, San Luis Obispo. He joined PFS Group in 2005 and is currently pursuing the designation of Chartered Financial Analyst. His professional designations include FINRA Series 7 and Series 66 Uniform Combined State Law Exam. He manages PFS Group’s Precious Metals Managed Account, Energy Managed Account, and Aggressive Growth Managed Account. Chris also contributes articles and Market Observations to Financial Sense and co-authors In the Know—a weekly communication for Jim Puplava’s clients only—with other members of the trading staff. Chris enjoys the outdoors.

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