Stock markets paused this week, consolidating recent gains. A number of divergences have begun to appear that may be signalling equity markets are running out of steam. This is a momentum driven market so it is troubling to see fewer stocks participating in the rally. While the S&P 500 reached a new 52-week high this week, less than 10% of stocks in the index confirmed the upside breakout. This contrasts with prior rallies in the S&P when over 25% stocks in the index were able to break out. So, we are watching to see if this non-confirmation is the start of something more serious for stocks. We think it might be.
In the meantime, the technical trend indicator remains in bullish mode, 34 points above the long-term moving average. With valuations (S&P 500 trades at 19.7x 2013 earnings) and confidence running high, risks of a downside break in markets are increasing.
Economic: Retail sales in the US came in slightly ahead of expectations this week (+0.4% versus +0.1%) and jobless claims also improved at 323,000 versus an aggregate forecast of 335,000. However, the Philadelphia Fed Manufacturing Survey reported a weaker than expected result. It was also reported that another 775,000 men dropped out of the US labour force as the male labour participation rate hit its lowest level since records began. Although the US unemployment rate is not rising, the real number of unemployed Americans is much higher than actually reported.
Technical: From a technical standpoint, the trend still looks okay, though market breadth has started to diverge. The Advance/Decline Line has stalled at new highs, unable to keep pace with the recent stock market rally. There is still little urge to sell as momentum investors continue to chase performance through yearend.
Strategy: The stock market remains overvalued, overbought in the near-term and investor sentiment has reached an optimistic extreme. We therefore maintain our cautious stance for now with an allocation in the model portfolio of 20% stocks, 50% bonds, 20% gold and 10% cash.
Next update: Monday 2nd December 2013.