There's two ways out of the jam we are in right now, the jam of a huge run that's been pretty much without so much as a pause in the averages. It's very rare that we can sustain this kind of endlessly positive move. Rallies end or take a break, either by matador or by Pamplonian exhaustion.
It's the way the hot streak runs out that matters. The first possible course is a big, ugly decline. The second way out is a benign treading of the waters for a couple weeks. We're due for one or the other. I am betting that we get the latter, the benign work-off, because I like this market, but I want you to know what the former could look like and be prepped for it so you will be ready.
Every once in a while I talk about the fabulous service I pay for from Standard & Poor's called the proprietary short-range oscillator. The information belongs to S&P and it's not free, which means it's an anathema to many. However, it is worth every penny, and after days and days of rallying last night it hit 10, which is traditionally a level of danger because it says the market is severely overbought.
Now we know from our Off the Charts segment that severely overbought stocks can cause a level of quick, short-term vulnerability that makes it so you would be nuts not to trim something from your portfolio. Sure, it can stay overbought for a while, but it's prudent to take something off the table when we see that number.
It's a natural thing to do, just like it is natural that if the oscillator, which measures buying and selling pressure, were to go to minus 10 -- another rarity -- you would need to cover your shorts or do some buying.
Normally the index comes in within about five points of zero, which is neutral. If it goes over five I get nervous, but when it goes over 10 I get downright fretful, because it often happens when the market looks so great as it has lately that you are the least prepared for it. Again, that's the mirror image of when it falls to minus 10, where you have to hold your nose and do a lot of buying.
But here's the issue: nothing, no indicator, is ever 100% right. We've seen extremes before and sometimes they just work themselves off by the market meandering for days and days -- the second, benign course.
Sometimes, though, stocks just keep plunging as they did during the Great Recession, when you would have been obliterated by buying stocks at minus 10 because they just kept going down and down and down to amazingly hideous levels.
That's why, today, reluctantly, we had to peel off some shares of stocks we owned for the charitable trust, ActionAlertsPlus.com, because discipline trumps conviction, and right now discipline says we're being greedy if we don't -- and greed, unlike in the movies, is bad, not good.
Now that doesn't mean this market is finished. Not at all. Remember, Joe DiMaggio had a remarkable 56-game hitting streak, but when the All-Star slugger then failed to get a hit in the next game he was hardly washed up.
That's what I think will be the case here with this market, but you are now forewarned.
OK, so now that you've heard my discipline spiel, we have to think about what could trigger a sell-off and what could cause us to muddle through, which was the happy way the bulls got out of the last extreme reading.
Let's start with a natural source of trouble: the banks, because they begin reporting tomorrow with the release of JPMorgan's (JPM) numbers. Here's a company that's one of the jewels in the financial crown, an incredibly well-run beast of a bank with all sorts of business lines, not just lending. It does investment banking and bond and currency trading and equity issuance. It issues a ton of credit cards.
The problem is that other than lending and maybe credit cards, none of those businesses has been that robust of late. Plus the company can't make all that much money on lending because interest rates are so low. And the company can't make that much money on your deposits because they need to invest your money in non-risky assets such as short-term Treasurys, and unless the Fed raises short-term interest rates, JPM is not going to be as profitable as shareholders would like. Hence, the possibility of a disappointing number. Now the stock is down 4% for the year, so it's not like it's coming in hot. But it is up 10 points from its February lows when Jamie Dimon, the CEO, bought a boatload of stock, one of the most brilliant buys I have seen. That means there is plenty of room for disappointment.
But perhaps even more important, it's possible that JPM's numbers are so good that when the rest of the banks report, such as Wells Fargo (WFC) on Friday or Bank of America (BAC) on Monday, they might not be up to snuff by comparison. At least we know that Wells Fargo, which my Action Alerts PLUS charitable trust owns, has plenty of ability to announce a new buyback. But what I am talking about is that we will have to run a banking Gauntlet not unlike that traversed by Clint Eastwood in that seminal movie of the same name.
So that's one concern.
Second worry? We still can't get FANG to cooperate. In fact, the wrong FANG is winning the war here.
What do I mean? There are two FANGS -- there's Facebook (FB) , Amazon (AMZN) , Netflix (NFLX) and Alphabet (GOOGL) (my charitable trust owns FB and GOOGL), and then there's the second FANG, which happens to be the symbol for Diamondback Energy (FANG) . In this classic battle between high-growth stocks and a plain-old oil and gas company, it's pretty darned telling that the energy FANG, up 33%, is mopping the floor with F.A.N.G. It's crushing Facebook, which is up 11% and still hasn't taken out its high despite the run in the averages, or Amazon, which has only advanced 10% this year despite all the hoopla about Amazon Prime Day, or Netflix, which has lost 15% of its value this year, and Google, which is down 6%.
Diamondback FANG, 1, tech FANG, zero. That's pathetic.
Not only that, but the red-hot FANG just issued 5.5 million shares to buy some fabulous oil properties and it's still way ahead. Sure, the stock got hammered along with oil, which dropped two bucks right back to where it was yesterday. But what matters is that the big growth stocks of the era just aren't putting on the performance that's needed to attract new sidelined money. Instead, it's the flotsam and jetsam of the market that's hitting new highs, a smattering of consumer products stocks, obscure techs and some odd-job commodity plays.
It's not what's needed right now. The right FANG has to start catching up to the wrong FANG or else, and I hope it doesn't happen because Diamondback gets slaughtered.
Third, we've got a gauntlet of Fed heads talking tomorrow, and you can bet that someone is going to say the wrong thing for the bulls and that someone will be the major highlight for the day. You can hear the litany: the Brits have a new prime minister so that's solved, Europe is a little stronger, our employment is on fire, so bring on not one, but two hikes! Wow, I have scary Fed-speak down to a science.
So is all lost? No. Remember, we can muddle through here. We can work off the overbought position by having the stock market do nothing for a while. We can have a couple days that are down and they bring in buyers while cooling off the pace of the rally. We can bet that while there will be profit-takers, like my charitable trust, there's not enough new hot money or fearful retail money left to blast out of the market.
Still, let's stay vigilant. Take off some obvious gains as no one ever got hurt taking a profit. But then let the rest ride, wagering that if the market really gets hit, the buyers who have been patiently waiting finally decide to pull the trigger.