In theory, the starter's gun fired on Friday when the GOP said they had enough votes to pass the tax reform bill.
Unfortunately, Yogi Berra was once quoted as saying "In theory there is no different between theory and practice. In practice there is." The same thing goes for a military engagement. The rules of engagement and the plan of attack are drawn out in great detail in advance. Once the first shot is fired the plan goes out the window.
In theory, passing the tax cuts will produce a significant increase in S&P earnings and a corresponding increase in the S&P. In reality, much of those S&P gains may already be behind us since portfolio managers have been expecting this ever since election night 2016. The S&P is up 590 points since the election.
Since the passage of the tax cuts will mean lower taxes on stock sales in January there is very little incentive for selling in 2017. Obviously, every investor and portfolio manager has different reasons for selling but tax management is always a big factor.
The market "should" continue higher through December. That may not be a vertical ramp but the overall trend should continue.
We saw a lot of reversals on Friday. Many sectors had been down over the last couple of weeks and several had decent rebounds.
The biotech sector has been choppy since the high on December 4th and the Biotech Index posted a 1.56% gain on Friday. We do not know if this will continue back to resistance but the index has resisted making a lower low for the last month.
The chip sector had been down -8% since the November 24th high. Despite the sharp decline the sector had been resisting a rebound until Friday when it gained +1.49%. This helped the Nasdaq and the Russell 2000. Normally the chips lead the Nasdaq bith up and down. The sharp decline blunted the Nasdaq's gains but the tech index recovered as the big cap stocks recovered from the sector rotation drop. If the chips continue their rebound the Nasdaq could move to even higher highs.
Helping lift the Nasdaq to a new record high was the sudden return to correlation by the FANG stocks. When they all move in lock step the Nasdaq has no choice but to follow.
The Nasdaq blew through resistance at 6,900 to cap a rebound from the sector rotation lows from December 6th. As long as the big caps remain positive there is nothing keeping the Nasdaq from higher highs. The minor 119-point retracement in early December relieved the overbought pressures and the sector should be free to move higher.
The Dow Transports had an amazing rally in late November to set new highs at 10,400. For the last two weeks, they have been stalled at those historic highs. Friday's gain saw an intraday test of resistance at 10,435 and a minor retracement at the close. The volatility at the top should have equalized the overbought pressures from that monster spike. If the transports can move to a new high, it would provide support for the Dow to add to its gains.
The Dow shook off the prior week's decline to close at a new high. However, the resistance at 24,666-24,672 has held for the last three days. The Dow is at the top of its channel and it would not hurt for it to move slowly sideways for several days to equalize. However, positive news on the tax bill is likely to energize the industrial stocks in the index and Dow 25,000 is the obvious December target.
The advance/decline line on the S&P continues to make new highs despite a hiccup midweek. The minor decline on Thursday was due to 359 decliners and only 99 advancers. Monday, Tuesday and Wednesday saw the A/D ratio almost dead even. There was definitely some rotation in progress but hopefully Friday's news ended that for the rest of December. Remember, as long as this A/D line is moving higher, the market is not going lower.
It is interesting that despite the positive A/D line, the percentage of S&P stocks over their 50-day average has been flat at around 74%. You would have thought the 30+ new highs on the S&P every day would have been lifting more stocks over their short-term average. We have seen positive improvement in the percentage of stocks over the 200-day average at 79.8%. That is nearing the highs for the last two years.
Prior resistance at 2,650 has become support and the likely target for December is now 2,750. The uptrend support suggests that 2,650 level will hold unless there is a real washout.
The small cap A/D line hit a short-term low on Thursday and the rebound is a long way from setting a new high. The small cap Russell gained 1.55% and that was due to financials, chips and biotechs and probably some short covering from the -1.14% decline on Thursday.
I am not convinced that the small caps are going to continue higher. If they were to move over 1,550, we could see a real broad market rally begin but that is still 20 points higher and it is resistance. We need a couple days of decent follow through to be convincing.
The broader Russell 3000 Index posted nearly a 1% gain and a new high. After that short period of weakness, the R3K could be primed to move even higher. The index is just over the middle of its channel with positive indicators. This is the broadest representation of the entire market with the top 3,000 stocks.
You may have heard commentators talking about the High Yield Index (HYG). There is a strong correlation between the high yield debt and the direction of the S&P. There was a couple days last week before the Fed meeting when yields were slightly volatile along with the S&P. The HYG is the red line. Note it has crossed the S&P to the downside but only slightly. What we do not want to see is a repeat of the decline in 2015. If yields start to become erratic, the S&P typically mirrors that move.
In theory, the market should move higher as long as nothing happens to upset the votes on the tax cut package. There could always be a sell the news event at any time, but it should be a buying opportunity. I would worry about a significant volatility event in January once we are into the new tax year but that should be limited since the corporate tax cuts will provide a significant boost to earnings. Buy any dip but not on the first day. I would rather buy a rebound from the dip. Let somebody else determine the bottom.
Enter passively and exit aggressively!
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