correction ahead: momentum is dying...2019/03/11 · lines in the upper box in chart 2 plot the...

Cam Hui, CFA | [email protected]

Confidential — Do not duplicate or distribute without written permission from Pennock Idea Hub

Quantitative & Strategy

CORRECTION AHEAD: MOMENTUM IS DYING

March 11, 2019

EXECUTIVE SUMMARY

We have been cautious on the near-term equity market outlook for several weeks (see Here

Comes The Growth Scare and Still Bullish, But Time to Reduce Risk). We reiterate our point for

being bullish and bearish over different time frames. While we believe stock prices will be

higher by year-end, investors should be prepared for some turbulence over the next few

months.

We are now seeing definitive technical evidence of a softer market in the near term.

Momentum is dying, and across a variety of dimensions.

Our base-case scenario calls for a correction of 1–3 months in duration, but without a re-

test of the December lows. The depth of the pullback will be a function of any growth scare

and the details of the U.S.-China trade agreement. As always, we will be data dependent.

We have written before that we are both bullish and bearish on different time frames, and

current circumstances suggest different positioning for traders and investors. Traders with

time horizons of up to three months should be tilted bearishly and prepared to sell or short

into market strength. On the other hand, longer-term oriented investors should view any

market weakness as an opportunity to deploy funds into equities in anticipation of higher

prices later in the year.

Cam Hui, CFA [email protected]

Table of Contents

Momentum Is Dying .............................. 2

Weak Momentum Everywhere .............. 3

Weak Fundamental Momentum ............... 7

Recession Scare Ahead? ........................ 9

Still Bullish ............................................. 12

Buy The Dip, Or Sell The Rip? .............. 16

mailto:[email protected]

https://humblestudentofthemarkets.com/wp-content/uploads/2019/02/20190211-Here-comes-the-growth-scare.pdf


https://humblestudentofthemarkets.com/wp-content/uploads/2019/02/20190225-Time-to-reduce-risk.pdf



March 11, 2019


Momentum Is Dying

We have been cautious on the near-term equity market outlook for several weeks (see Here

Comes The Growth Scare and Still Bullish, But Time to Reduce Risk). We reiterate our point for being

bullish and bearish over different time frames. While we believe stock prices will be higher by

year-end, investors should be prepared for some turbulence over the next few months.

We are now seeing definitive technical evidence of a softer market in the near term. Momentum

is dying, and across a variety of dimensions. One key technique we use to monitor momentum

is the behaviour of different moving averages. If the shorter moving average starts to roll over

while the longer moving average continues to rise, that’s a sign of fading price momentum.

The chart below depicts the weekly S&P 500 chart, with a MACD histogram on the bottom

panel. Note how MACD, while still strongly positive, is starting to roll over. We find that the

weekly chart is useful for intermediate-term price moves while filtering out the noise from daily

fluctuations.

Exhibit 1: Momentum Rolling Over

Source: Stockcharts

In the past, such episodes have resolved themselves with either a sideways consolidation or

market downdraft. We expect the most likely outcome is a correction that will last 1–3 months,

followed by a resumption of the bull market.






March 11, 2019


Weak Momentum Everywhere

Evidence of fading price momentum can be found everywhere. The MACD rollover can be

found in a variety of stock indices. Here is the NASDAQ Composite.

Exhibit 2: NASDAQ Composite

Source: Stockcharts

The small-cap Russell 2000 is also rolling over.

Exhibit 3: Russell 2000

Source: Stockcharts



March 11, 2019


The fading price momentum effect can be seen globally. Here are non-U.S. developed market

equities, as measured by EAFE.

Exhibit 4: MSCI EAFE ETF

Source: Stockcharts

Emerging market stocks started to fade several weeks ago, ahead of developed markets.

Exhibit 5: MSCI Emerging Markets ETF

Source: Stockcharts



March 11, 2019


Risk appetite indicators are also losing momentum. The stock/bond ratio is exhibiting

a pattern of MACD histogram rollover.

Exhibit 6: S&P 500 to Long UST Ratio

Source: Stockcharts

High yield (junk) bond prices, net of interest rate effects, have been highly correlated

with stock prices, and momentum is dying as well in this asset class.

Exhibit 7: HY Prices Highly Correlated To S&P 500

Source: Stockcharts



March 11, 2019


Even more ominous is the analysis from John Murphy of Stockcharts, who concluded

the market may have peaked in late 2018 and it may be undergoing a topping process:

LONG-TERM MOMENTUM IS ALSO WEAKENING... The monthly bars in

Chart 2 show the uptrend in the S&P 500 that started exactly ten years ago. And that uptrend

is still intact. The sharp selloff that took place during the fourth quarter of 2018 stayed above

the rising trendline drawn under its 2009, 2011, 2016 lows. That's the good news. What may

not be so good are signs that long-term momentum indicators are starting to weaken. The two

lines in the upper box in Chart 2 plot the monthly Percent Price Oscillator (PPO). [The PPO

is a variation of MACD and measures percentage changes between two moving averages]. The

PPO lines turned negative during the second half of last year when the faster red line fell below

the slower blue line. And they remain negative. [The red histogram bars plotting the difference

between the two PPO lines also remain in negative territory below their zero line (red circle)].

Secondly, and maybe more importantly, the 2018 peak in PPO is lower than the earlier peak

formed at the end of 2014. That's the first time that's happened since the bull market began. In

technical terms, that creates a potential "negative divergence" between the PPO lines and the

S&P 500 which hit a new high last year. That raises the possibility that the ten-year bull market

may have peaked in the fourth quarter of 2018 and is now going through a major topping process.

If the peaking process in stocks has already started, that could start the clock ticking on the nearly

ten-year economic expansion that also started during 2009.

Exhibit 8: Did The S&P 500 Top Out In 2018?

Source: Stockcharts


http://stockcharts.com/members/analysis/20190309-1.html


March 11, 2019


Weak Fundamental Momentum

In addition to evidence of fading price momentum, the market is also faced with the prospect

of negative fundamental momentum. The latest update from Yardeni Research Inc. shows that

forward 12-month large cap EPS estimates edged up last week, but within the context of a

multi-week downtrend. The strength in large cap estimates was not confirmed by mid and small

cap estimates, both of which continued to fall.

Exhibit 9: Weakness in Forward EPS Estimates

Source: Yardeni Research, Inc.



March 11, 2019


We can see the effects of price and fundamental momentum from two ETFs. The relative

performance of MTUM (black line) represents the returns of a pure price momentum factor.

By contrast, FFTY is the IBD 50, which relies on a composite of fundamental and price

momentum factors to construct its portfolio. As the following chart shows, the relative

performance of both factors have been highly correlated until last fall. Since then, price

momentum has been flat to down during the latest rally, while IBD 50 momentum has begun

to roll over in the last few days.

Exhibit 10: Momentum Factors Are Weak

Source: Stockcharts



March 11, 2019


Recession Scare Ahead?

Last Friday’s shockingly weak Employment Report also raises some concerns of fading macro

momentum. While the weak February headline Non-Farm Payroll figure could be attributable

to a data blip, or mean reversion from the strong January report, the internals of the report

show signs of economic weakness. Temporary employment, which has historically led NFP, is

topping out. This suggests that employment will weaken further in the coming months.

Exhibit 11: Temp Jobs Lead Non-Farm Payroll

Source: FRED, Federal Reserve Bank of St. Louis

Equally worrisome is the deceleration in construction jobs, which has either been coincident or

led past recessions. That’s not a surprise, as housing is a highly cyclical industry and a key

barometer of economic health.



March 11, 2019


Exhibit 12: Construction Job Growth Is Decelerating

Source: FRED, Federal Reserve Bank of St. Louis

The message from the commodity markets is equally downbeat. Despite an apparent recovery

in industrial metal prices, the internals are less bright.

Exhibit 13: An Apparent Recovery in Industrial Metal Prices, But…

Source: Stockcharts

However, IHS Markit observed that global metal users’ PMI has been declining, which is

indicative of a softening manufacturing environment.


https://twitter.com/ihsmarkitpmi/status/1103685961521737729?s=11


March 11, 2019


Exhibit 14: Global Metal Users PMI Weakening

Source: HIS Markit



March 11, 2019


Still Bullish

Despite these short-term negatives, we remain bullish on equities to year-end, and believe that

any growth scare is only temporary in nature for several reasons.

The first reason is the existence of a Trump Put. Bloomberg reported that Trump believes his

2020 re-election prospects go through the stock market:

President Donald Trump is pushing for U.S. negotiators to close a trade deal with China soon,

concerned that he needs a big win on the international stage — and the stock market bump that

would come with it — in advance of his re-election campaign.

As trade talks with China advance, Trump has noticed the market gains that followed each sign of

progress and expressed concern that the lack an agreement could drag down stocks, according to people

familiar with the matter. He watched U.S. and Asian equities rise on his decision to delay an increase

in tariffs on Chinese goods scheduled for March 1, one of the people said.

Trump has become obsessed with stock prices as a metric of his administration’s success. Even

if the much-anticipated trade deal doesn’t produce a market pop, he may be tempted to take

other means to boost stock prices.

Trump’s fixation on stock-market performance has shaped his assessments of his economic policies.

Top White House staff know to be aware of how markets are performing when summoned to the

Oval Office to speak with Trump because the president often asks: ‘‘What’s happening with the

markets?’’

The second reason is the Powell Put. The minutes of the January FOMC meeting make it clear

that the Fed is monitoring the stock market [emphasis added]:

Following the briefing, participants raised a number of questions about market reports that the

Federal Reserve’s balance sheet runoff and associated “quantitative tightening” had been an important

factor contributing to the selloff in equity markets in the closing months of last year. While respondents

assessed that the reduction of securities held in the SOMA would put some modest upward pressure

on Treasury yields and agency mortgage-backed securities (MBS) yields over time, they generally

placed little weight on balance sheet reduction as a prime factor spurring the deterioration in risk

sentiment over that period. However, some other investors reportedly held firmly to the belief that the

runoff of the Federal Reserve’s securities holdings was a factor putting significant downward pressure

on risky asset prices, and the investment decisions of these investors, particularly in thin market

conditions around the year-end, might have had an outsized effect on market prices for a time.

Participants also discussed the hypothesis that investors may have taken some signal about the future path of the federal funds rate based on perceptions that

the Federal Reserve was unwilling to adjust the pace of balance sheet runoff in light of economic and financial developments.

In addition, both the BAML Fund Manager Survey and the compilation of State Street investor

confidence from Callum Thomas of Topdown Charts shows that institutions are already

defensively positioned. While other segments of the markets, such as retail investors, are not

similarly cautious, these readings should put a floor on stock prices in the event of bearish news.


https://www.bloomberg.com/news/articles/2019-03-06/trump-is-said-to-push-for-china-deal-with-market-gains-in-mind

https://www.federalreserve.gov/monetarypolicy/fomcminutes20190130.htm

https://www.linkedin.com/pulse/top-5-charts-week-callum-thomas-15d/


March 11, 2019


Exhibit 15: Institutions Are Already Very Defensive

Source: Topdown Charts

Lastly, investors should not ignore the powerful effects of a breadth thrust. If history is any

guide, stock prices are almost invariably higher after a breadth thrust such as the one

experienced in January, even though interim corrections may occur shortly after the event.



March 11, 2019


Exhibit 16: Breadth Thrusts Are Long-Term Bullish

Source: Stockcharts

We had highlighted the results of our own historical study in a past report (see Still Bullish, But

Time to Reduce Risk) indicating that excess return (bottom panel) weakens after two months and

then rises thereafter. Moreover, three and six month maximum drawdowns are in the 11-13%

range, indicating the possibility of a interim pullback.

Exhibit 17: Breadth Thrusts Are Long-term Bullish, But Short-term Corrections Possible

Source: Pennock Idea Hub





March 11, 2019


We went back 20 years and found very few instances like the one we are encountering today.

There were not many episodes where the weekly MACD histogram had been deeply negative,

rose strongly, and rolled over. In all cases (n=3), the market pulled back. In two of the three

cases, the correction was relatively minor and the market did not re-test its previous low.

Exhibit 18: A Likely Correction Ahead

Source: Stockcharts



March 11, 2019


Buy The Dip, Or Sell The Rip?

Our base-case scenario calls for a correction of 1–3 months in duration, but without a re-test

of the December lows. The depth of the pullback will be a function of any growth scare and

the details of the U.S.-China trade agreement. As always, we will be data dependent.

We have written before that we are both bullish and bearish on different time frames, and

current circumstances suggest different positioning for traders and investors. Traders with time

horizons of up to three months should be tilted bearishly, and be prepared to sell or short into

market strength. On the other hand, longer-term oriented investors should view any market

weakness as an opportunity to deploy funds into equities in anticipation of higher prices later

in the year.



March 11, 2019


Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am

confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit

every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but

final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing

this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for

the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may

contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and

assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of

the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,

express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

Confidential — Do not duplicate or distribute without written permission from Pennock Idea Hub


correction ahead: momentum is dying...2019/03/11 · lines in the upper box in chart 2 plot the...

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