I want to believe

Mid-week market update:  One of the running themes of the TV show, the X-Files, is a poster on the wall of FBI agent Mulder with the caption “I want to believe”.

 

 

As the S&P 500 breaks out at the 6000 resistance level and Street strategists scramble to their index targets, I also want to believe in that stocks can go higher, but I have my doubts.

 

 

 

The Bull Case

Here is the bull case.

 

An analysis from Deutsche Bank shows that institutions sold into the “Liberation Day” panic. While equity weights have recovered, they are still lightly positioned in equities.

 

 

As well, a MarketWatch article revealed that Datatrek analysis shows that institutions are piling back into equities. This leaves the potential for more momentum-driven buying.

 

 

The S&P 500 and the NYSE Advance-Decline Lines are staged upside breakouts to all-time highs, which is bullish. However, the lagging nature of the mid-cap S&P 400 and S&P 600 A-D Lines does serve as a warning that not breadth indicators are participating in the rally.

 

 

The macro backdrop has also improved. The U.S.-China handshake deal announced will relieve some of the rare earth supply chain pressures on semiconductors. The Semiconductor Index has staged an upside breakout on an absolute basis. More importantly, it has staged a relative breakout against the S&P 500, and against utilities, which is a bullish risk appetite signal.

 

 

Both the Russell 2000 and S&P 600 also staged upside breakouts, which are positive signs of small cap strength.

 

 

The pain trade increasingly looks like a rising equity market, based on the combination of light institutional positioning, recovering risk appetite, and positive macro news.

 

 

Nagging Doubts

Nevertheless, I have nagging doubts.

 

While positive equity flows from institutions is a bullish sign, short-term institutional investment time frames is measured in quarters, not hours and days. As a consequence, they need to depend on valuation to guide their asset allocation. The latest analysis from Pimco shows the equity risk premium at zero, which is extremely low by historical standards. Based on that analysis, U.S. equities will experience significant subpar returns, which will limit their flow.

 

Michael Howell of Crossborder Capital, who keeps an eye on global liquidity, observed in his newsletter a positive liquidity backdrop in the short-term, but potential struggle in Q3.

Global liquidity edged higher last week to US$176.6tr, according to measures derived from the weekly balance sheets of the major Central Banks and collateral values. Still, the slowdown in global liquidity growth continues. Central Banks – particularly the Fed – need to step up to avoid a liquidity shortfall in Q3 when the debt refinancing season comes around. If the current slowing trend continues through June, risk assets and liquidity-sensitive cryptocurrencies will struggle in Q3.

 

From a technical perspective, the S&P 500 upside breakout leaves nagging doubts. Even as the S&P 500 breached the 6000 level, why is the equal-weighted S&P 500 struggling below resistance? Why is the 14-day RSI flashing a negative divergence signal? Why are gold miners, which is regarded as a safe haven asset, performing so well? The bottom panel shows that gold miners have performed roughly in-line with the S&P 500 during the rally off the April bottom.