Our Focus List has gone according to plan. It represents how O'Neil style money management occurs by narrowing down the list of names into the best performers even during challenging market environments. While we have sent out Pocket Pivot and Buyable Gap-Up reports, we have been cautious about adding much of anything to the Focus List due to the tenuous market environment. This past week, a number of names in our reports came undone breaking down on heavy selling volume. This is no surprise, since these names were all in later-stage positions in their chart patterns, a primary reason why we have remained skeptical of more recent pocket pivots and buyable gap-ups in this market.
While we have remained focused on the few best names, we also have anticipated a market that is vulnerable to an overdue correction, so loading the list up with names that are less than stellar is misguided given the market environment. The question is whether the market will find a relatively shallow floor as it has so many times since 2009. This time, however, the interest rate environment has changed with rates clearly on the rise as witnessed by spiking yields across the board. But the counterargument to a deep correction are the economic policies in place that are helping boost U.S. GDP.Nevertheless, maintain a close eye on price/volume action as always in stocks you monitor. Stay on the lookout for potential undercut & rally moves when the market stages a bounce. Such patterns have been the most profitable so far this year. The time value relative to risk in such trades remains strong.
Deeply in Debt
According to the U.S. Treasury, U.S. federal debt increased by nearly $1.3T in fiscal 2018. It is the sixth largest fiscal-year debt increase in U.S. history. The national debt now totals $21.5T.
The total amount of bonds purchased by world governments as part of their quantitative easing operations exceeds $16 trillion. And that's just for bond purchases. Countries such as Japan have been buying up their own stocks with the QE capital flow. Indeed, governing bodies are often the largest shareholders in the most liquid stocks. And corporate debt is not much better off. We know that stock buybacks in the US will amount to more than $1 trillion this year thus exaggerating earnings.
Yet bond yields are hitting new multi-year highs across the board, with the 10-year blowing past 3% while the 2-year rapidly approaches 3% with it hitting a high in yield not seen since 2008. Meanwhile, the 10-year Treasury note yield hit a 7 year high while the 30-year bond yield hit a 4 year high. The 20-year+ bond ETF TLT continues to fall, plummeting on Wednesday, Thursday, and Friday. As a consequence of all this, the yield curve has steepened slightly. So even though QE continues to flow, interest rates remain on the rise. This suggests the economy in the U.S. is strong enough to withstand further rate hikes.
Unemployment reached its lowest level since 1969 achieving a 49-year low. Further, the ISM logged its second highest reading in history on Wednesday raising expectations for GDP growth and reinforcing future rate hikes by the Federal Reserve, enabling them to further refuel the interest rate gas tank so they will have ammunition when the next recession hits. This spurred the selloff in bonds. Meanwhile, the still robust flow of global QE certainly adds a necessary cushion to an artificially driven QE market, and thus explains the relatively shallow floors set in the major stock indices.
Stocks vs. Bonds
But that said, rising yields can serve as a headwind for stocks. As yields rise, bonds can become more attractive to some compared to stocks which are considered riskier. Further, climbing rates make borrowing more costly for individuals and corporations alike.
Over in the major indices, we had a cluster of distribution days on the NASDAQ Composite accompanied by sluggish overall action of many names. The NASDAQ Composite closed below its 50dma while the S&P 500 bounced off its 50dma and the small cap Russell 2000 bounced off its 200dma. The divergences are only worsening between major indices thus remain pronounced. Nevertheless, in between potentially sharp stock market corrections, should GDP growth match expectations, this old bull could grow older still.