What Use is an Unloaded Gun

The title of today’s report is a pearl of wisdom on the importance of being prepared from none other than Tony Soprano.

Over the last couple of weeks, I started re-watching the epic series, “The Sopranos.” It's amazing how many more of the nuances of the show I’m picking up now with another decade of life under my belt.

So, let me try to provide you with a loaded gun of market wisdom to better help you navigate the seemingly contradictory market environment of new all-time highs.

Last week provided us with new all-time highs in both the S&P 500 (SPY) and theNasdaq (QQQ). In addition to those equity markets, both the US High Yield (JNK) and US Investment Grade Corporate Bond (LQD) markets also made new all-time highs.

However, there are a number of discrepancies between what I would expect to see as markets are making all-time highs and what is actually playing out right now. While both the S&P 500 and the Nasdaq were breaking out to all-time highs, US Treasuries (TLT) also broke out to a new 12-month high and more importantly, TLT broke out and closed above 22-month downtrend line that began when Treasuries peaked back in July 2012.

This occurred as 10-year yields broke down to 11 month lows. So, US equity markets are screaming “growth” and yields are saying “not so fast.” Let’s look at the futures positioning of the “smart” money. These are the large speculators that trade in the futures markets.

These investors have flipped to a net short position in S&P futures over the last couple of weeks as the SPY has been grinding higher. Large specs have their lowest long exposure to Nasdaq futures in over a year and a currently net short Russell 2000 (US Small Cap, IWM) contracts by more than 2 standard deviations away from the 1-year average.

It’s not just the “smart money” that’s positioning itself defensively against US equity markets. Over the last month, there have been large scale outflows from both US-listed exchange traded funds (ETFs) and mutual funds. Investors have yanked $8B out of ETFs and another $9.5B out of mutual funds.

Another important aspect that can validate a new all-time high is the breadth of the move. Are there a lot of stocks involved in the move or is the index being pushed to a new all-time high by just a few stocks?

With the S&P 500, we can drill down to the sector level to determine which parts of the economy are participating in this move higher. The 9 sectors of the S&P are decidedly split on the new all-time high. Five sectors joined the S&P last week in making new all-time highs: basic materials (XLB), energy (XLE), industrials (XLI), consumer staples (XLP) and technology (XLK).

That leaves 4 sectors that aren’t buying it: utilities (XLU), health care (XLV), financials (XLF) and consumer discretionary (XLY).

Utilities peaked in early May and are currently 1.8% off their all-time highs. Health care peaked in early March is is now 0.80% off the all-time high. Consumer discretionary also peaked in early March and remains 2.9% off the all-time high.

And finally, financials, remain 30% below the all-time high made in 2007, and they also remain 1.6% below the new 6-year high they made at the end of March.

Another aspect of an all-time high that you want to evaluate is the involvement across market caps. Obviously the S&P 500 represents the large to mega cap companies in the US.

All-time high? Check.

US Midcaps, represented by the S&P 400 (IJH), made a new all-time high on April 4, 2014 and is currently 1.4% off that high. US Small caps, represented by the Russell 2000 (IWM), made a new all-time high on March 4, 2014 and is currently 6% off that high. So, let’s summarize the current cirmustances.


S&P 500 (SPY) – All Time High on Friday May 30, 2014.

1.      Sector Participation – 5 out of 9.

2.      Market Cap Participation – none.

3.      Smart Money Positioning – reducing long exposure significantly and/or moving to net short.

4.      Dumb Money Positioning – selling equity ETFs and mutual funds in record amounts over the last month.

5.      Critical Ancillary Markets – US yields making a new 11-month low, US Treasuries breaking out of a 2-year downtrend!

Oh, and did I mention that last week was also the final week of May? Month and quarter-end window dressing by fund managers is a widely known phenomenon and usually leads to a low volume melt up into the end of the month.

The SPY’s 1.2% gain last week, which pushed it to a new all-time high, occurred on volume that was half of its weekly average over the last 6 months. To wrap this commentary up let’s look at the circumstances surrounding the new all-time high that SPY made back on December 31, 2013.


S&P 500 (SPY) – All Time High on Tuesday December 31, 2013.

1.      Sector Participation – 6 out of 9. 2 of the non-participating sectors were off their all-time highs by 16 and 27 basis points respectively. As opposed to today where the non-participating sectors are off any where from 80 to 290 basis points.

2.      Market Cap Participation – midcaps, yes. Small caps made an new all-time high 5 days prior and were off 53 basis points. As opposed to today, small caps made a new all-time high 3 months ago and are off 600 basis points. Midcaps made a new all time high 2 months ago and are off 140 basis points.

3.      Smart Money Positioning – Net long across S&P 500, Nasdaq and Russell 2000 futures.

4.      Dumb Money Positioning – net buying of equity ETFs and mutual funds in the month of December.

5.      Critical Ancillary Markets – US yields making a new 3 year HIGH and US Treasuries (TLT) sitting at 3-year lows.

 “Stocks? You gotta be high up in the corporate structure to make that s@#t work for you. We don’t have those Enron type connections.” Luckily Mr. Soprano is wrong, you don’t need to be a C-level exec or have inside information to profit from the financial markets. You just need to have a solid process that effectively filters out the noise of the markets, focuses you on what really matters and informs you how to trade the markets that are in front of you.