Stocktake: Broad-based rally augurs well for stocks

US indices have been hitting all-time highs but the biggest gainers in 2016 have been defensive rather than cyclical sectors. Does this indicate investors are positioned for a market slowdown?

No. Stocks have endured a drawn-out correction since May 2015’s peak. Looking back on 20 similar market environments, Sundial Capital Research found defensives led gains on 14 occasions; defensive leadership is the norm, not some rare, sinister omen.

Secondly, defensives are not propping up indices; this has been a very broad-based rally. Last week, 84 per cent of stocks traded above their 50-day moving average. Breadth readings were even higher in seven out of 10 S&P 500 sectors.

Notably bullish increases in breadth have occurred in cyclical sectors such as industrials and technology, with the Nasdaq last week closing above 5,000 for the first time this year. Global market breadth has been similarly strong; one breadth indicator tracked by Bespoke Investment Group last week hit its highest level since December 2012.

Breadth had been deteriorating for some time prior to May 2015’s peak, but the opposite has true of recent months. This is bullish; stocks look like they’re headed higher.

Bulls cheered by breakout
Market breadth is not the only indicator of continued market gains; the very fact stocks have broken out of their long trading range augurs well.

LPL Research found 13 previous occasions where the S&P 500 endured a full calendar year without hitting new all-time highs. After stocks broke out, they were higher a year later on 12 occasions, enjoying above-average gains of 14 per cent.

Similarly, Nautilus Research found 17 previous occasions where stocks hit multi-year highs following a long market pause. Stocks rose on every single occasion; one-year gains averaged 15.5 per cent.

No other technical signal is “as robustly bullish for a longer-term horizon”, making it the “mother of all buy signals”.

These results are not a fluke. Stocks break out of long trading ranges for specific fundamental reasons. Indices approached their May 2015 highs on innumerable occasions over the last year only to be rebuffed every time. That has now finally changed, indicating further new highs lie ahead.

Don't underestimate momentum
The next year looks good, but what about the coming weeks? After such a furious advance, are stocks vulnerable to profit-taking?

One technical indicator suggests the S&P 500 was last week more technically extended than at any time since May 2013. Additionally, the 7.6 per cent 10-day advance was the biggest 10-day rally since December 2011.

Momentum usually carries stocks higher over the next month, however. Since 2000, there have been 18 similar 10-day advances, notes LPL Research; a month later, indices were higher on 13 occasions, enjoying above-average gains.

Obviously, this time may be different. However, traders shouldn’t assume what goes up, must come down; market strength usually begets strength.

May to clamp down on pay?
Theresa May's appointment as UK prime minister has cheered markets but some chief executives are not likely to share this relief.

May has condemned the "irrational, unhealthy" gap between executive and worker pay, and called for annual binding votes on executive pay packages. Institutional investors appear to share this exasperation, given recent shareholder rebellions at companies such as CRH, BP, Deutsche Bank and WPP.

Companies should heed the advice of PricewaterhouseCoopers (PwC), which last week released a report urging remuneration committees to clamp down on executive pay before politicians force them to do so. The average FTSE 100 bonus is around three-quarters of the maximum, PwC noted, with four out of five companies paying above target levels each year.

Political attitudes have turned “increasingly toxic”, as evidenced by May’s criticisms; such largesse may be reined in sooner rather than later.

Most forex traders lose money
Think you can make a bundle trading the foreign exchange (FX) markets? A new survey of 133 retail FX traders indicates you should think again.

More than half (58 per cent) had experienced account-closing losses; 39 per cent suffered this costly indignity at least twice. Many – 38 per cent – never checked bid-ask spreads before placing trades while only a quarter checked broker interest rates, even though these are the two biggest transactional costs in FX trading. Almost three-quarters traded at least daily, but this wasn’t because they were good traders – there was no correlation between trading frequency and overall performance.

Some (38 per cent) made money over the previous six months; most (49 per cent) lost money. The true stats are likelier to be ugly – more than half of respondents were trading for over four years, so this was a relatively experienced sample.

The traders' thoughts can be viewed athttp://goo.gl/ME9C5v.

Don’t expect any great insights, however – as the CXO Advisory blog drily noted, the survey “offers little evidence that traders know what causes good and bad trading performance”.