Investors in Risk-On Mode, but Watch for Speed Bumps

In one of the strangest weeks for the markets that I can remember, the major indices collapsed during the overnight session on election night, with the S&P 500 plummeting 5% at one point, before staging a huge bullish reversal on Nov. 9. From there, the market just kept going, and all major indices posted big gains for the week, led by the small-cap Russell 2000, which added 10.2%.

Meanwhile, long-term U.S. interest rates spiked higher as investor assets poured out of Treasury securities (which move inversely to yields) and into stocks. The rise in long-term rates steepened the yield curve, helping to power the financial sector to an 11.2% one-week gain, making it the strongest performing sector by far.

Utilities were the weakest sector, down 4% for the week, as yield-seeking investors fled in favor of safer -- and now much better yielding -- Treasuries.

The table below, which displays Asbury Research's ETF-based metric, shows that the biggest inflow of assets over the past one-week and one-month periods went into financials at the expense of utilities and consumer staples.

Market Holds Major Support

In last week's report, I pointed out that the Volatility S&P 500 (VIX) index hit a fearful extreme of 23.01 on Nov. 4, while the benchmark S&P 500 declined to major underlying support at its 200-day moving average. I said this established favorable conditions for the broader market's 2016 advance to resume.

The S&P 500 rallied 4% last week, suggesting the market's larger trend is indeed still intact and healthy.

Last week's rally positioned the index just below overhead resistance at 2,180 (Sept. 22 high) to 2,194 (Aug. 15 high). It would take a sustained rise above these highs to confirm that the broader market's next leg higher is underway.

Market Volatility Still a Factor

As the S&P 500 was streaking higher last week, the VIX collapsed back toward complacent extremes, hitting a low of 13.26. It finished last week at 14.17, just below its 50-day moving average at 15.09. This indicates investors have moved back into complacent mode, a condition that has historically coincided with near-term stock market rallies.

However, the VIX's close proximity to 12 warns that the S&P 500's near-term upside may be limited, just as it did before the past two minor market declines -- in mid-August and late September. 

So, the good news is that last week's strong rebound signals the broader market's larger advance is intact. The potentially bad news is that the VIX remains low while the S&P 500 is testing minor overhead resistance, which could trigger another pullback in the market before it can make and hold new highs.

A New Trend of Rising U.S. Interest Rates

In the Oct. 17 Market Outlook, I said the recent rise above 1.75% in the benchmark yield of the 10-year Treasury note suggested an emerging trend change toward higher rates and cleared the way for a test of the next important resistance level at 1.94% to 1.98%.

Yields spiked right through 1.98% last week to the next overhead level at 2.23%. This confirms the major trend change and sets yields up for a test of the next important level at 2.32% to 2.36%, which represents the closing highs from late 2015.

Although much of last week's big jump in yields was attributable to "risk-on" asset allocation -- as investors rushed out of the safety of Treasuries and back into the stock market -- the bigger message is that the forward-looking bond market appears to be betting on improving economic conditions heading into next year.

Gold's Big Reversal Suggests Major Trend Change

In last week's report, I pointed out gold prices were testing and holding major underlying support, suggesting their larger 2016 advance may be resuming. But the market seems to have changed its mind in a hurry after the election.

After testing and rebounding from its 200-day moving average in October, SPDR Gold Shares (NYSE: GLD) has collapsed back below it. Note that GLD failed at its 50-day moving average at the end of the month before collapsing below the 200-day late last week.

The reversal was the result of a quick shift in investor sentiment to risk-on mode, which suddenly made defensive gold less attractive. This is a perfect example of what it looks like on a price chart when conditions change and the market changes its mind with them.

In the bigger picture, we see GLD may be tracing out a bearish head-and-shoulders pattern. As long as the $119.44 to $122 area contains prices as overhead resistance, this pattern suggests gold prices peaked at the July highs and could eventually be headed all the way back to where they started in January.

Putting It All Together 

Although Donald Trump's shocking victory last week initially sent global financial markets into a panic, stocks and long-term interest rates shot higher the next morning while defensive gold prices collapsed. The violent reversal toward a risk-on stance appears to indicate that investors believe the Trump administration will be more favorable to U.S. business.  

However, last week's sharp rally positioned the S&P 500 just below overhead resistance while volatility has collapsed, warning of a pullback before the market can establish and hold new all-time highs.

Editor's note: While you wait for a pullback, consider this question: Would you steal from Wall Street if you could get away with it? A former military intelligence analyst found a legal way to skim hundreds, even thousands of dollars from the stock market. It's easy to do and takes just 2-3 minutes per transaction. Watch her revealing video here.

[Market Outlook] Why I Can't Stop Talking About The 200-Day Moving Average
Premium Content  | Amber Hestla | February 12, 2019

Many investors hold strong opinions about the 200-day MA... but is it actually important?