December Conference Call: 5 Key Takeaways

1. Stocks Hold First-Half Highs

Significant levels of interest were put to the test last week, but buyers showed up when they needed to and successfully defended them.

When we look at the Dow Jones Industrial Average and the Dow Jones Transportation Average, the importance of those May highs can't be overstated. Nothing good happens if we lose these levels, just like nothing good happens with the S&P 500 Index below 4,500.

For now, the primary uptrends for the large-cap averages are intact, and these key pivot highs are holding up. We’re simply going through a prolonged consolidation phase. The tactical trend is most definitely sideways, though, which is why we continue to experience choppy and range-bound price action.

For now, it looks like we just had a successful retest of the May highs. Seeing stocks hold above their first-half highs is a positive development. With that said, many areas are just barely holding on and appear vulnerable. If these levels are violated, we’re likely to revisit the lower bounds of these year-to-date ranges, and the broader market is likely to come under further pressure if we do.

2. Continuation Patterns Tend To Continue

While it's true that things are a hot mess in the short term, when we zoom out, we can see most of these ranges are flag patterns within an ongoing uptrend. Because these are merely continuation patterns, we're giving the benefit of the doubt to the bulls and anticipate that these consolidations will eventually resolve higher. 

These kinds of digestive periods are not just normal; they're necessary during a healthy bull market cycle. Remember that markets don't move in a straight line. They need to consolidate gains from time to time before they can resume their path higher. We've been witnessing corrective price action all year, particularly in the weakest and most vulnerable areas, such as mid- and small-caps.

As these continuation patterns tend to resolve in the direction of the underlying trend, our bet is that buyers will eventually take control and send prices higher. If this doesn't happen though, and these ranges resolve to the downside instead, that would be critical information. Seeing these patterns fail would be an incredibly bearish development and would put our bullish outlook for stocks into question.

For now, buyers continue to dig in and defend the lower bounds of these ranges. Until we get some resolutions in one direction or the other, we expect these messy market conditions to persist.

3. New Highs Are Non-Existent

While the S&P 500 snapped back and achieved new all-time highs last week, participation beneath the surface remains a major concern. The amount of stocks that made new highs along with the index last week was at its lowest reading of the current bull market cycle.

In fact, new highs in the S&P 500 were accompanied by more stocks making new lows than new highs on the New York Stock Exchange last week.

The bottom line is that breadth has not been this thin since the COVID selloff last year. We’re seeing fewer and fewer stocks make new highs with the major indexes. 

We’re also seeing this internal weakness in our scans as finding bullish setups has become more and more difficult. Participation needs to increase in a meaningful way if the broader US equity market is going to resolve higher from all these year-to-date ranges.

4. It's Still a Mess

The same bull flags and continuation patterns we discussed above can be described as hot messes when we zoom in on these charts.

The formation in the Value Line Geometric Index has become the norm for 2021. The majority of stock market sectors and indexes, outside of the US large-cap averages, are simply consolidating in sideways patterns. The same is true for many commodities -- just look at copper and crude oil. 

As you can see in the chart, we’re also seeing this same range-bound action in many of our intermarket and risk appetite ratios these days. The High Beta vs. Low Volatility ratio tends to rise in environments where investors are embracing risk. Risk-seeking behavior is a characteristic of strong bull markets, so equities generally have a very strong correlation with this ratio.

If we looked at some of our other ratios such as High-yield vs. Treasuries, Stocks vs. Bonds, or Copper vs. Gold, we'd see the exact same story. They are all chopping sideways in year-to-date holding patterns. 

When we zoom out, though, the primary trends remain intact and still point higher for these charts. For this reason, we still want to give stocks, commodities, and these risk-appetite ratios the benefit of the doubt and err in the direction of upside resolutions. But we’re probably going to need to remain patient, as there are no signs of this happening yet.

5.  Mixed Signals From Bonds

The US 10-year and 30-year yields bounced back last week after undercutting our risk levels earlier in the month. For the 30-year, we’re watching those summer lows near 1.80%. For the 10-year, all eyes are on the former cycle lows around 1.40%. Both of these levels were reclaimed last week, and we’re still trading slightly above them today. 

With that said, we aren’t seeing strong follow-through from these failed moves. Instead, rates are once again chopping sideways just slightly above these levels. As long as this remains the case, we think markets are vulnerable. 

The bond market has been sending some warning signals in the form of inflation expectations hitting their lowest level since September and Treasury spreads recently falling off a cliff. Bank stocks also continue to be lackluster, as they barely participated in last week’s bounce. 

On the other hand, we can’t ignore the fact that the 5-year continues to show strength and is trading just off its recent highs. While the evidence is still mixed, we want to approach yields with caution here, as more and more data is beginning to support further downside action. 

The bulls want to see the 10-year play catch-up to the 5-year, but we're just not seeing that yet. If the long end of the curve continues to hold above the summer lows, we're giving yields the benefit of the doubt and betting on them catching higher in the future.

But if we see a sustained move lower, it’s likely happening in an environment where risk assets are coming under further pressure. We're watching these charts closely to see how they react at these critical levels.

That’s it for this month’s key takeaways!

As always, Premium Members can re-watch the Conference Call and view the slides here!

We hope you enjoyed our recap of this month’s call. Thanks for reading, and please reach out to us with any questions!

Allstarcharts Team