Why does the market feel so bearish when the S&P 500 and the Dow Industrials just hit new all-time highs?

April is normally one of the most bullish months of the year for stocks but it certainly didn't feel that way on Friday. Early gains on Friday reversed and the NASDAQ plunged -110 points for its worst one-day loss in two months. Small caps and technology stocks continue to underperform while transportation, housing, and energy stocks displayed relative strength. Oil declined. Precious metals like gold and silver delivered a small bounce. U.S. bond yields reversed early gains to close on their lows for the week.

The week started on a strong note as stocks applauded what appeared to be improvement in diplomatic tensions between Russia and the U.S. as Putin called Obama to discuss the situation in Ukraine. The new Federal Reserve Chairman Janet Yellen also gave stocks a boost on Monday when she said the Fed still has work to do and said the U.S. "economy needs extraordinary support for some time."

The S&P 500 and the Dow Jones Industrial Average managed to hit new all-time highs. So why the sell-off on Friday? It's possible that traders decided to interpret Friday's jobs report, which continues to show slow and steady growth, as reinforcement that the Fed will continue to cut its QE program. It could also be a technical move since the S&P 500 failed three times below round-number resistance at the 1900 level. It's also possible that traders were selling equities to raise cash to pay taxes since April 15th is almost here.

Economic Data

Most of the U.S. economic data last week was actually up or relatively flat. Construction spending rose +0.1% in February after dropping -0.2% in January. Factory orders rose +1.6% in February following a -1.0% in January. Auto sales in March surged +9.7% year over year. The ISM manufacturing index rose from 53.2 in February to 53.7 in March. ISM services came in at 53.1 in March, up from 51.6 in February. Numbers above 50.0 suggest growth. The Dallas Federal Reserve manufacturing survey hit a six-month high with it rise to 4.9. The Chicago PMI was a disappointment with a drop to 55.9.

The ADP Employment Change Report said private companies added +191,000 jobs in March. That was below estimates but the February number was revised up from +139K to +178K. Economists were expecting between +185,000 to +200,000 new jobs in the nonfarm payrolls report. Friday's jobs number came in at +192,000. February's NFP report was revised up from +175K to +197K and January was revised higher from +129K to +144. All in all it was a positive read and marked the third monthly rise in jobs for the first time in three years. The unemployment rate was unchanged at 6.7% for the second month in a row.

While the jobs report is showing growth it is slow growth. It takes +150,000 new jobs a month just to keep up with new graduates and new immigrants joining the U.S. workforce. We've seen the U.S. gain over two million new jobs in the last four years but it's still the slowest jobs recovery on record, going back to when they started tracking this data back in 1939. We still need another five million new jobs to get back to pre-recession levels. At the current rate of jobs growth that could take us another five years.

Overseas Data

Economic data in Europe was relatively flat. The Eurozone GDP number was adjusted lower from +0.3% growth to +0.2% for the previous quarter. The manufacturing PMI for the Eurozone was unchanged at 53.0. Meanwhile the Eurozone unemployment rate ticked lower to 11.9%.

The European Central Bank was busy last week. As expected the ECB left their interest rates unchanged at 0.25%. Elsewhere ECB officials were actively denying rumors they had already planned a one-trillion euro QE program to stimulate the economy. Deflation is becoming a bigger and bigger threat for Europe so they would rather risk inflation and try to speed up economic activity with more money.

The economic data from China wasn't so hot. The HSBC China Manufacturing PMI number inched lower from 48.1 to 48.0. Numbers under 50.0 indicate economic contraction. The Chinese government had been hinting at a new stimulus program and they finally announced new plans for more infrastructure projects, more low-income housing, and stimulus for small business. Meanwhile the China Banking Regulatory Commission announced they will perform their own stress tests for regional and national banks.

Major Indices:

The S&P 500 lost -1.25% on Friday but still managed a +0.4% gain for the week. Year to date the S&P 500 is up +0.9% versus declines in both the NASDAQ and the Russell 2000. Unfortunately Friday's action looks bearish. As you can see on the intraday chart buyers tried to push the S&P 500 toward the 1900 level three times. All three times it failed near 1897. That's close enough to call it a failed rally at round-number resistance.

The S&P 500 index should find some support at 1840. If that level fails the 100-dma near 1825 and the 1800 level could also offer support. A drop to 1800 would be a -4.7% decline from its all-time closing high of 1890 set on Wednesday, April 2nd.

intraday chart of the S&P 500 index:

chart of the S&P 500 index:

The action in the NASDAQ looks pretty ugly. Friday's move produced a -2.59% drop and a breakdown below its late March low and a breakdown below technical support at the 100-dma. Declining stocks outnumbered advancing stocks 5:1 on Friday. Last week's move looks like a new lower high and the up trend over the last year is now in serious jeopardy.

The next levels to watch for potential support are 4100 and the 4000 area. Currently the NASDAQ is down -1.1% for the year but it's off -5.5% from its March highs.

chart of the NASDAQ Composite index:

Weekly chart of the NASDAQ Composite index:

The small cap Russell 2000 index ($RUT) looks a lot like the NASDAQ. Last week produced a new lower high. Unlike the NASDAQ the $RUT is still holding above its late March low and the 100-dma, at least for now. The $RUT lost -0.8% for the week and is now down -4.8% from its all-time highs set in early March.

The 1140 level should be support but if we see the $RUT breakdown below the March low I would not expect 1140 to hold. That means the new levels to watch for support are 1120 and 1100, which should be bolstered by the rising 200-dma.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index

Economic Data & Event Calendar

The economic and event calendar this week is pretty light. However, we will see the Q1 earnings season begin, which could be significant. Dow-component Alcoa (AA) reports on Tuesday, after the closing bell. More importantly we will hear from big banks like JPMorgan Chase (JPM) and Wells Fargo (WFC) on Friday.

Economic and Event Calendar

- Monday, April 07 -
Moody's business confidence
German Industrial Production

- Tuesday, April 08 -
Alcoa (AA) kicks off Q1 earnings season

- Wednesday, April 09 -
Wholesale inventory data
FOMC minutes

- Thursday, April 10 -
Weekly Initial Jobless Claims
import/export prices

- Friday, April 11 -
Producer Price Index (PPI)
University of Michigan Consumer Sentiment

Additional Events to be aware of:

April 18th - U.S. markets closed
April 30th - FOMC interest rate decision and outlook

Looking Ahead:

At the beginning of the year Wall Street was expecting Q1 earnings growth of +5%. Three months later, after one of the worst winters in years, analysts are only predicting +0.31% earnings growth. That could be our saving grace. There have been so many earnings warnings regarding the first quarter that expectations are so low we could see a lot of earnings surprises.

On the other hand, because expectations are so low and corporate management has a convenient excuse to blame Q1 results on the weather, this could turn into a "kitchen sink" quarter where management tosses everything negative they can into the earnings report to get rid of it and off the books. This turns the fast approaching earnings season into a two-edged sword. If you're bearish then you're worried about companies beating already super-low expectations. If you're bullish then you're worried about companies sinking their results and blaming it on the weather. The only prediction I feel strongly about is an almost guaranteed chance of increased volatility.

Warning Signs

The current bull market is five years old and it's been called one of the most hated bull markets in history. It seems like lately everyone has been rushing to call the top and declare the end of the bull market on every pullback. This time the bears have something going for them. Every time the Federal Reserve terminates a QE program the market declines.

The bears have five years of history on their side. Now currently the Fed is still buying billions of bonds and mortgage backed securities every month but they started cutting back on QE in January. Bulls will argue this argument is invalid given the S&P 500 just hit a new record high a few days ago. It is worth considering that at the current pace the Fed's QE program will end this year and the market is a forward-looking machine.

Another worrisome development is the number of IPOs in the market. There has been speculation that the rush of IPOs is actually signaling a top for the stock market. We've already had 70 IPOs this year. Every time a company goes public it's a diversion for investor cash that could have gone somewhere else. In the last 30 days we've seen about 50 IPOs. Is there a connection between the flood of new stocks coming to market and the underperformance in the NASDAQ and the Russell 2000?

A new record high for margin debt is another ominous headline. Granted the bears have been pointing at this factor for a long time and it hasn't really had any bearing on the market. Peter Boockvar, with the Lindsey Group, has made an interesting observation. Margin debt at the NYSE hit an all-time high of $465.7 billion in February 2014. Boockvar suggests we measure this number against U.S. GDP. The current level of margin debt is 2.7% of nominal GDP. Near the market top in 2007 margin debt hit 2.6% and at the market peak in March 2000 we saw margin debt hit 2.8%.

Another interesting statistic is suggesting we are due for another recession. Over the last 60 years the United States has averaged a recession every 5.2 years. The most recent one, the "Great Recession", ended in Q2 of 2009. That means we just crossed the five-year threshold since our last recession. Does that mean this summer we're going to see the U.S. economy tank?

I do not want to be Chicken Little claiming the market is about to crash. That would be a hard argument to make when the Dow Industrials and the S&P 500 just hit all-time highs this past week. However, the underperformance of the broader NASDAQ composite (3,000+ stocks) and the Russell 2000 index (2,000 stocks) is troubling. This market has gone almost 900 days without a normal -10% correction. The NASDAQ and the $RUT are half way there with -5% declines from their recent highs.

Earnings season is about to start and that means individual stocks could see significant volatility as traders react to corporate results. I would be somewhat hesitant to launch new positions unless the stock you're considering is showing significant relative strength.