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Pro Analysis

Santoli: Don’t chase this rally overdue for a setback


A trader works on the floor of the New York Stock Exchange (NYSE).
Lucas Jackson | Reuters
A trader works on the floor of the New York Stock Exchange (NYSE).

No need to chase the latest spurt in the stock indexes to fresh record highs. But don't run away from the market, either.

When someone says "Don't chase this rally," it's important to get clarity on what's really being said. Some market observers are just spoilsports, or reflexively contrarian without any basis. Other times, it's a euphemistic way to argue that risks are high and the market is in grave danger – so get out now.

The call I'm highlighting - after the S&P 500 pushed two-thirds of a percent above its former high of 2300 to 2316 last week - is neither of those. Right now, and looking out several months, the broad market advance appears solid – supported by upturns in corporate earnings and global economic activity, while accompanied by rock-solid credit conditions. Indexes hitting record highs are not in themselves a cause to worry, and are in fact a regular and welcome feature of bull markets.

It's just that the tactical setup at the moment isn't ideal for strong or lasting short-term gains, making the tape somewhat more susceptible to disappointing developments than to unexpected upbeat news. It's now pretty easy to find seasoned market handicappers who are pretty bullish about where this market ultimately is headed, but think it's prone to a setback or continued doldrums in the near term.

Tony Dwyer, strategist at Canaccord Genuity, has had a 2340 2017 target for more than a year and now says that may be too conservative. Yet since December he's been telling clients to stay patient, wait for some tactical indicators to cool off and be ready to buy any "fear-based selloff" of perhaps 5 percent.

He's been concerned by the elevated investor sentiment readings and narrowing market leadership. Dwyer notes, too, that the S&P hit a new record Thursday with 60 percent fewer NYSE stocks reaching a 52-week high than at December's peak. Prior similar instances have led to the S&P being down the majority of the time the next month one and two months.

Deutsche Bank strategist Binky Chadha's core call is even more optimistic – he sees the S&P 500 hitting 2600 by the end of the year, up another 12 percent from here, on a V-shaped earnings and economic rebound and continued shift of capital into equities from bonds and other "defensive" assets.

Yet he says the "economic surprise" indexes that have boosted risky assets are due to roll over in coming weeks, largely because forecasts have been raised. Selloffs of 3 to 5 percent are typical every two to three months in bull markets, and 5 percent-plus drops have come every five to six months. While not at all clockwork patterns, we're due for a setback by both those guidelines.

Chadha argues the rally has not been mainly about President Trump or his policies, but that they could produce both choppiness and eventual added upside down the road: "With little priced in for policy changes, selloffs on any stimulus disappointment should be short lived. We expect sharp selloffs on announcement of a [border-adjustment tax] or significant trade frictions and such selloffs to act as a check and balance on the actual follow through and implementation of adverse policies and see them being moderated or phased in over a longer period in response."

When a market has gone as long as this one has without much drama – calmly hanging near record highs for two months, with 84 days and counting without a 1 percent loss – it gets inspected closely for small operating flaws and signs of wear.

Dana Lyons of J. Lyon Fund Management is flagging the unusually low percentage of trading volume in advancing stocks last week on a day when the indexes hit a new 52-week high. Cutting the data from a few angles, Lyons concludes that this kind of action doesn't reliably stop a rally in its tracks, or lead to poor long-term returns – but it has meant much higher-than-average odds of stocks being down over the next couple of months.

What to do, then?