As stocks flirt with new highs, don't dismiss these risks
Much has gone right for U.S. equities over the past few weeks. As a result, the Dow Jones industrials index is now just below the 18,000 level it last crossed in July, setting up a possible breakout from a three-year sideways crawl.
This follows a historic rebound off the Feb. 11 low that reversed one of the worst starts to a year ever, after a horrible performance in January. For a seven-year-old bull market, the nimbleness as taken many by surprise.
But will it last? Can the gains continue? Or will the resistance near 18,000 (chart below) once again foil the market bulls?
A number of catalysts have helped get us here.
Officials from Russia and the OPEC countries have talked up a potential deal to freeze oil production. Federal Reserve policymakers have repeatedly hinted that until inflation becomes a clear and present threat in the U.S., they're willing and able to use an ever-changing list of worries (a slowing China and the U.K.'s "Brexit" are the latest) to justify holding off making additional rate hikes. And the start of the first-quarter earnings season, expected to be the worst since 2009, has pleasantly surprised (relatively) as big bank results haven't been as bad as feared.
But some of this may be starting to fade now.
U.S. equities slipped on Friday as investors looked toward the weekend meeting in Doha between Russia and the various OPEC nations concerning a possible oil supply freeze deal that's been bandied about -- and has been boosting oil prices and stocks -- since February.
Wall Street analysts have busily downplayed oil-patch expectations. Iran remains a wild card, vowing to not sign any deal unless it allows the country to ramp back up to pre-sanction output levels of near 4 million barrels per day (vs. around 3.3 million now). And a Russian official has warned that any agreement is likely to be loosely worded, which means it probably won't include any hard enforcement mechanisms.
With major producers already pumping near capacity, a freeze isn't likely to change the supply-demand balance.
At least China showed some evidence its economy has turned a corner. While first-quarter GDP growth slowed slightly (rising 6.7 percent vs. 6.8 percent previously), other data was more constructive. Industrial production rose 6.8 percent vs. 5.4 percent in the January-February period and ahead of the 5.9 percent expected. Fixed-asset growth improved, as did credit growth.
With downside risks to the Chinese economy one of the reasons the Fed has said it wanted to be patient with rate hikes this year, the data should do much to ameliorate these concerns and provide policymakers with one less excuse for delaying further interest rate hikes.
We'll know more about the Fed's outlook soon when it releases a policy statement later this month ahead of its June meeting. The futures market doesn't expect action until December, but that may be too long of a wait for the next rate hike.
On Friday, dovish Chicago Fed President Charles Evans said he still expects two rate increases this year (with three a possibility depending on the economic data). And he said a June rate hike could be appropriate (something the market puts just 15 percent odds on). On Thursday, St. Louis Fed President James Bullard said higher interest rates could actually help the economy's performance, by boosting bank profits, for instance.
However, a sooner-than-expected rate hike would be a definite negative for a stock market still very reliant on ultralow interest rates.
Here are two more factors to consider:
For one, buyers have been focusing on a narrowing group of stocks over the last few weeks. This is a sign of vulnerability for an uptrend because narrowing participation in a rally suggests investors see fewer attractive issues at current prices. The 20-day moving average of the NYSE advance-decline line peaked near 900 in March and has slid to less than 300 now. A similar pattern was seen as stocks topped between October and December last year ahead of the January wipeout.
And two, we're about to enter a period of seasonal weakness in the stock market. You know: "Sell in May and go away." According to Jeff Hirsch of Traders' Almanac fame, given the market's weak performance since the end of October (the start of the "best six months of the calendar year" based on his seasonal research), we could be in for a rough summer, assuming stocks end April slightly lower.
Since 1950, when stocks have declined for the six months starting in November, the S&P 500 has declined 71.4 percent of the time, or 10 of 14 years, for an average loss for the year of 9 percent.
