August Outlook: Rally Lacks Tech and Small Cap Support
By: Jeffrey Hirsch & Christopher Mistal
July 28, 2016
July’s big rally has pushed the DJIA well into incumbent winning territory. As you can see below this has not been typical July market action. The usual second half of July weakness never materialized. Once the market realized that Brexit was no imminent threat or a clear and present danger, stocks quickly erased the two-day post-Brexit selloff and rallied to new all-time highs on the DJIA and S&P 500 in relatively short order.
Since economic data has not impressed the Fed enough and continues to ebb and flow every month, it’s unlikely we’ll see another rate increase until after the election. Earning season went off without a hitch as companies overall did not disappoint Wall Street much, though we were not overly impressed. 
Buoyed also by earnings numbers that mostly beat lowered forecasts and the promise of continued accommodative monetary policy for the foreseeable future, this rally has pushed the DJIA well above any of the rosiest scenarios for an election, which has historically, been a vote of confidence for the incumbent presidential party.
[8th year update chart]
The market had been rocking this July until midway through the Republican National Convention last week and has not budged this week during the Democratic National Convention this week. All the hype about overly raucous, contested conventions with riots in the streets has been largely standard fare with the usual lively and inspired outbursts from enthusiastic constituencies. 
Trump got a standard convention bounce along with the market last week. We will find out next week if Clinton’s convention bounce will appear and propel her odds of winning the White House and the stock market higher. But for now the rally appears to have stalled, making zero headway since last Wednesday.
If anything we should all find at least some solace in the continued civilized, yet enthusiastic and sometimes heated debates of the open political process that this great nation continues to be built on. However, as two of the most unfavorable candidates head into the home stretch of a virtual dead heat presidential election campaign, things are bound to get uglier and spook the market.
August has been a horrible month for the stock market, ranking last for the major indices, DJIA, S&P 500, NASDAQ and Russell 2000 from 1988-2015. August performance improves dramatically in election years, ranking first for NASDAQ and Russell 2000. But election Julys rank poorly, likely due to convention distractions and that did not occur this time around. July may have stolen August’s election year thunder.
The market typically takes a breather in the early part of August and it sure seems out of gas now and ready for a pit stop. With 60 days left until the first Presidential debate and 103 days until they election, we have to imagine the mud will start to fly again and that might derail the rally, at least temporarily. This rally clearly lacks tech and small cap support. Until the NASDAQ and Russell 2000 log new all-time highs of their own, this rally will struggle to gain traction and be prone to summer swoons.
Pulse of the Market
Brexit vote losses were recovered in short order. Momentum carried DJIA and S&P 500 (not shown) to new all-time highs (1), but the rally has stalled. As of yesterdays close the faster moving MACD indicator applied to DJIA is negative (2), confirming the loss of upward momentum. Absent a 100-plus DJIA point gain today, the slower moving MACD indicator will also turn negative.
Dow Jones Industrials & MACD Chart
After declining in three of four weeks in June, DJIA has been up four straight, but gains have been shrinking (3). The current weekly winning streak is under pressure this week. A Down Friday/Down Monday (DF/DM) cluster in June (4) turned sentiment adequately bearish to fuel the recent rally. A DF/DM cluster near the lows or around support has proven in the past to be an excellent short-term long trade opportunity. A similar occurrence near highs or resistance can also mark the end of a rally.
S&P 500 (5) and NASDAQ (6) have also enjoyed gains for four straight weeks. S&P 500 did reach new all-time highs however, NASDAQ has not. We continue to look for NASDAQ and Russell 200 to trade at new all-time highs to confirm this rally has further to go. Absent tech and small-cap support, the rally is not likely to last as long.
NYSE Weekly Advancers and Decliners (7) over the last four weeks have been trending in a direction that confirms the market’s waning momentum. Weekly Advancers have been slowly declining in number while Decliners are rising. NYSE Weekly New Highs peaked and Lows bottomed out (8) during the week ending July 15. This is another possible sign the rally is fading.
Moody’s AAA Rate bottomed at 3.21 (9) in the week ending July 8. This is the lowest level for this key rate on record going back to 1962. This new low was likely part defensive, part optimism for additional central bank liquidity and part hunt for yield. The expectation of further liquidity and lower interest rates was likely the largest force. Thus far, most central banks have not taken any additional action and the rate has begun to drift higher. 
Click for larger graphic…
Pulse of the Market Table