U.S. Stock Market - Record Highs, But Then Down On The Week

The closely-watched Dow Jones Industrial Average, the S&P 500 Index, and the New York Composite Index all printed record highs last week, but each of them posted a loss on the week. Bulls and Bears were both equally frustrated last week.

Is it too early to call someone "Legendary" when he's earned 28.5% compounded annually over the last 20 years for his investors (net of fees!)? In addition to a stellar return for his investors, David Tepper, founder and chief executive at Appaloosa Management (a hedge fund) earned $3.5 billion for himself last year, which makes him the top dog in the hedge fund industry for 2013. I think it's safe to use the word "Legendary" when describing David Tepper in terms of his investment management skills. However, I don't think we can use the same word to describe his oratory skills.

At the SALT hedge fund conference in Las Vegas last week, Mr. Tepper used the following words to describe his recommended position in the U.S. Stock Market here:

“Don’t be too fricking long right now!”. “The market is kind of dangerous right now,” said Tepper. "I’m nervous.” 

Tepper's less-than-positive comments on the U.S. Stock Market probably contributed to last Thursday's slide of about 1% in most major averages. However, buyers were back on Friday and most major stock indexes recovered about half their losses sustained the prior day.

So where does that leave us?

The S&P 500 Index, the New York Composite Index, the Dow Jones Industrial Average, and the Dow Jones Transportation Average all remain close to record highs, while the Nasdaq Composite is down about 6% from its 2014 high, and the Russell 2000 is down about 9% from its record high. So-called momentum stocks, the big winners from last year, are down about 20% to 60% (or more) from their all-time highs, depending upon the name.

Bottom line: Large-cap stocks are showing remarkable resilience in the face of significant recent damage to small-cap stocks and momentum shares. However, I remain convinced that the entire equity market will move in sync on the downside very soon. While I am unsure what the negative catalyst will ultimately be, I strongly suspect that most investors will soon come to the realization the Federal Reserve is now in "tightening" mode. I feel that most market participants are underestimating Chair Yellen's resolve to end Quantitative Easing (at least for now). The vote on the latest $10 billion taper was 12 - 0 in favor. And the vote on the next $10 billion taper will almost certainly be unanimous in favor as well. Corporate earnings won't be strong enough to offset a Federal Reserve that is sending strong signals that "the punchbowl won't be refilled any time soon" and maybe the party is over!

Russell 2000 Index Weekly Bar Chart with 30-Week Moving Average Line

S&P 500 Index Weekly Bar Chart with 30-Week Moving Average Line

When The Soldiers Fall, How Soon Before The Generals Surrender?

One of the more interesting stories from last week is the extent of outflows (redemptions) currently being experienced at key exchange-traded funds (aka ETF's) like the Russell 2000 iShares (symbol IWM). This is the largest of the small-cap ETF's with $23.6 billion under management where outflows totaled $2.2 billion, or 8.6%, last week. The smaller leveraged cousin ProShares Ultra Russell 2000 actually lost an incredible 41.4% of its assets under management last week. While outflows in the largest ETF of them all, the SPDR S&P 500, weren't nearly as significant on a percentage basis (-1.77%), the total redemption (outflow) in the SPY ETF was still noteworthy at $2.8 billion last week. 

The Russell 2000 Index closed below its 200-day moving average line last week, and most technical analysts are all asking the same question. Will the small-cap stocks rebound or will large-cap stocks soon turn down to match the losses sustained recently in small-cap stocks? My best guess is reflected in my current position which is effectively a leveraged bearish short in the S&P 500 Index (using the SDS ETF). 

The Russell 2000 Index peaked on March 4th, 2014 at 1,212.80. It then fell almost exactly 10% to an intra-day low at 1,091.50 this past Friday, May 9th before bouncing about 1%. If the 5-year bull market in U.S. stocks is still alive, then small-cap and battered momentum stocks will rebound sharply in the days and weeks ahead, and the larger stocks will probably tread water or trend slightly higher. If a major correction is now underway, as I believe is the case, then the large-cap "generals" will soon fall sharply to join the small-cap "soldiers" in full retreat.

Russell 2000 Index Daily Chart with 200-Day Moving Average Line

Russell 2000 Index Weekly Chart with 20-Week & 40-Week Moving Average Lines

P.S. In my February 16th, 2014 column I wrote the following: "Gold/Silver mining stocks are probably "fairly valued" now and should therefore be scaled back or completely liquidated in most portfolios." Gold/Silver mining shares had rallied between 30% and 100% from their December 2013 lows to their February peaks, and my recommendation in mid-February was to take profits and wait for the next great opportunity in this volatile sector. While my computer system has yet to trigger any meaningful "buy" signals here, on Friday, May 9th I purchased several Gold/Silver mining shares for the first time since February. My allocation to this sector went from 0% to 14% this past Friday. While 14% may seem high, my allocation to this sector peaked at 40% in late December 2013. Right now, I like Silver more than Gold, but if one rallies then both will probably rally. And if/when the Silver ETF (symbol SLV) advances above it long-term downtrend line at $20/share, then upside potential for silver mining shares looks explosive. In the interest of full disclosure, I am now long First Majestic Silver (AG), Endeavour Silver (EXK), and Primero Mining Corp (PPP) in my largest managed account.