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Monday, May 22, 2017

THE WEEK AHEAD

The Week Ahead



May 22, 2017

The major indices had their worst day in 8 months last Wednesday, as investors thought that Donald Trump got into real trouble after a series of smaller scandals. It caused a major selloff in risky assets globally. The decline was baked in the cake according to some traders, as stocks had an extended period of record-low volatility, and a correction was needed to reset the bullish sentiment. The FxVolatilian thinks that the swift and convincing recovery toward the end of the week could mean that we have already seen the end of the pullback, and new all-time highs are just around the corner, despite the negative summer seasonality. On another positive note, the previously lagging S&P 500 and Dow managed to outperform the Nasdaq during the week.

Economic numbers were once again mixed at best, despite the blowout reading of the Philly Fed index, as the CB Leading Index, building permits, housing starts, and the Empire State Manufacturing Index all came in below consensus estimates. The index of economic surprises hit a 12-month low, confirming the recent tendency, although the labor market continues to show strength, with new jobless claims still being very low. Industrial production was also slightly better-than-expected. Rate hike odds still fell sharply with regard to the rest of the year, causing a strong rally in Treasuries and a slump in the dollar. It will be interesting to see the Fed’s reaction to the political turmoil and the string of weak economic numbers at the FOMC’s next meeting in June.

Technicals are slightly less bullish in the wake of the broad correction, but some of the negative divergences eased, and the generally constructive picture is far from being threatened. The major indices are still all above their 50- and 200-day moving averages, although the S&P 500 and the Dow dipped below the short-term indicator on Wednesday. The Nasdaq remained above both averages, despite the scary correction, and it bounced off the crucial 6,000 level without penetrating the technical "support." The Russell 2000 remains suspiciously weak, as the small cap index closed the week below its 50-day average, while being much closer to its 200-day indicator as well. The Volatility Index (VIX) exploded by more than 50%, above 15, amid the sell-off, but it drifted lower during the recovery and stands at 13 currently.

Market internals are still showing weakness, but some of the measures remained surprisingly strong amid the correction, which could be the start of a healing process. The Advance/Decline line held up well thanks to the quick rebound, even though declining issues outweighed advancing stocks by a 2-to-1 ratio on the NYSE and by a 3-to-1 ratio on the Nasdaq. The average number of new 52-week highs declined only slightly on both exchanges, falling to 101 on the NYSE, and 124 on the Nasdaq. The number of new lows jumped significantly, climbing to 61 on the NYSE, and 77 on the Nasdaq. The ratio of stocks above their 200-day moving average stopped declining despite the broad weakness, and finished the week unchanged near the 65% level.

Short interest rose in most of the sectors, although the positive fundamental news caused a wave of short covering in the battered energy segment. RPC (RES) benefited from the rise in the price of oil, jumping by 15% in a few days, while the short ratio even increased to a whopping 56%. Spark Energy (SPKE) also gained more than 10%, following its recent slump, and the short interest of 48% suggests that there is more “fuel” for the rally. Digital Realty (DLR), one of the leaders on the list with the highest days-to-cover ratio (DTC), barely budged during the selloff, and bears are still in deep trouble, as the ratio is still at 15. Our previous candidate for a short squeeze, Brown-Forman (BF-B), rose by almost 10% in a week, while its DTC ratio remained at 11, pointing to further troubles for shorts.

The developments regarding Trump’s Russian ties will likely keep the media and traders busy in the coming period, although this week’s OPEC meeting could also cause fireworks, at least in the energy sector. The economic calendar is almost empty until Friday, when the crucial durable goods report will come out together with the prelim GDP growth reading. New and existing home sales will also be released earlier on, but the minutes of the FOMC meeting will probably have the biggest market impact on Wednesday. The FxVolatilian hopes that last week’s slump will prove to be a “one-day wonder," and that the major indices will be back on track to continue one of the longest bull runs in history. Stay tuned for a crucial week on Wall Street!

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