Zeller Kern’s Investment Monitor

Are New Market Highs in Doubt?

April 19, 2017

By Steve Zeller

For the past few weeks, the market has been experiencing greater volatility and weakness that has erased returns in a number equity asset classes for the year. The Dow Jones Industrial Average has remained in a minor corrective phase that began off of its high of 21,169 achieved on March 1st.

As of the market close last Thursday, The Dow Jones Industrial Average was up 4.18%, year to date, the S&P 500 was up 4.64%, while the Russell 2000 Small Cap Index was down -0.51%, according to Morningstar.com. The markets overseas, show a little more strength with the MSCI EAFE (Europe, Asia, and the Far East) Index up 6.44%, and the Hang Seng Composite Index up 11.52%. The good news is that the S&P 500 Index was up over 11% from its pre-election November levels.

S&P 500 Index 1 Year Chart

The question in many investors’ minds is this market behavior a representation of a major bull market top, or, is this a simple corrective pattern, that will usher in new highs later this year? From our vantage point, the indicators are somewhat mixed at this point. Technically speaking, the market momentum recently has indicated a growing weakness. This weakness is partly due to growing uncertainty from a geo-political perspective, a la the growing potential of a conflict with North Korea, as well as the uncertainty taking place within Washington. There is increasing concern among investors as to whether or not there will be any real tax reform or health care reforms taking place anytime this year.

This political uncertainty may have an impact on the market achieving new highs later this year. In other words, if tax reform isn’t taking place, it may be enough to take away the animal spirits that have been driving the market upward. The economy, though positive in many areas, has some concerning areas that could potentially create some headwinds. Retail sales declined – 0.2% in March, versus the expected Econoday consensus of 0.0%. Additionally, the Census Bureau revised its February numbers from 0.1% to -0.3%. January numbers, though revised down, was adjusted to 0.5% versus the prior number of 0.6%. Some economists view the retail sector as being in trouble. Vehicle sales are a main culprit, with the sector suffering three straight quarters of decline, with first quarter sales being down -1.2%. Other areas of decline include sporting goods, which fell -0.8%, restaurants fell -0.6% and building materials declined -1.5%, for February.

An interesting observation is that consumer prices declined unexpectedly -0.3 % in March. The core rate (minus food and energy) fell -0.1 %. Energy prices fell -3.2% for the month, with gasoline being down 6.2%. The trend for autos hasn’t been favorable lately. This has been developing on the heels of consumers racking up record debt to finance those purchases, and the negative trend has been persisting for three straight quarters. (Click chart to enlarge)

Consumer Price Index for All Urban Consumers

Auto sales have rising for eight straight years, according to a recent article posted by Casey Research. The industry sold a record 17.55 million vehicles last year. But recently, sales have been plummeting.

As a result, auto inventories have been stacking up and auto manufacturers are cutting production. According to an article published at caseyresearch.com, auto manufactures produced 18% fewer cars in January of 2017 than in January of 2016. But the question is, does this give indication of what is coming for other areas of the economy? Will this bleed over into other consumer spending? Recent data suggests that could be the case.


Normally, our view would currently be that this trend is typical within an economic cycle. But as we have been arguing for several years, record debt levels are a very dangerous condition to future economic growth, and auto loans are no exception. As you can see illustrated by the chart below, auto loans are at a record high. According to the chart from the St. Louis Fed, auto loans reached a record $1.11 trillion at the end of the fourth quarter of 2016.

Motor Vehicle Loans Owned and Securitized, Outstanding (MVLOAS)

The issue of auto loans dovetails into the overall issue of debt of which the total debt load is huge. The point is, without any serious tax reform and other fiscal stimulus happening soon, it could cause a serious interruption to the direction of the U.S. stock market and the economy overall. We remain hopeful, that this pull back is temporary, and we’ll resume the march upward to new highs before this eight year bull market is over. But the current economic data points that have been recently reported, the political uncertainty and flip flopping in Washington, along with other economic headwinds over in Europe in relation to Italy’s debt problems, and possible negative political outcomes, strengthens the argument that we won’t see further market highs anytime soon.

We should get a better sense of the market direction in the coming weeks. This week will bring in the beginning of the earnings season with about 250 companies releasing reports. But there are some very substantial releases and could set the tone for the earnings season. But all of the uncertainty and challenges that we discussed could be too much for any positive earnings reports.  This week’s economic reports are minimal with the focus primarily on housing which is beginning to have some serious declines in activity along with industrial and manufacturing reports. There are some critical support levels that are now in range for the market to fall through. If that happens, that could significantly disrupt longer term market trends.

Looking back on last week
Headlines last week continued to give market participants caution as stories were flowing out of both Syria and North Korea. With the holiday shortened week, Monday was the only positive session with a 0.07% gain on the S&P 500. The market continued then declined for the balance of the next three sessions, finishing near the low for the week and below the key support with the S&P down 1.13%

North Korea took center stage at the beginning of the week after the Navy ordered a strike group towards the Korean peninsula. This prompted rumors of Chinese troop movement along the North Korean border but these claims were later refuted by Chinese Defense Ministry.

Trump added further fuel to the fire as he commented that he would like to see China’s help in diffusing the North Korean situation but that the US military was willing to do it on its own.

This kept the pressure on the downside throughout the week as the geopolitical front led the way as far as market sentiment goes. On Wednesday, Secretary Tillerson was in Moscow to discuss issues surrounding Syria which did not help market sentiment.

Market sentiment continued to deteriorate throughout the week as illustrated through the VIX as it closed at the highest level since the election. The market wrapped up an abbreviated week with the third consecutive loss as investors refused to be swayed by a handful of bullish catalysts and remained focused on the geopolitical risk.

Thursday’s action continued the slide, trading below the critical 2337.25 level and finishing at 2328.05. This close below the support level suggests that we will test the critical level between 2323/2320 early this week. A penetration will suggest a further decline toward the 2316/2309 levels.

Momentum has failed completely on a short-term basis, suggesting this downward pressure will remain. Even if there is a minor rebound, it will be “Sell the rallies” for the short term. The sideways trading range that we talked about over the past couple weeks has been broken and all bets are off for a rally on the short term. It will be key how the market acts around the 2323/2320 levels. If there is no sharp bounce off of these levels, then we are likely to see the markets move down to at least 2309 and the possibilities now of moving down to the 2290/2284 levels.

Intermediate charts also continue to lose momentum as most of the upward trend pressure has dissipated. This puts the market in a very vulnerable place. As we have discussed over the past several weeks, it is critical that the market trades above the 2400 level by the end of this month.

The probabilities for this to occur are now only 40%, suggesting there is a high probability that we are going to see an intermediate to long-term top form at this level.                 

*Last week’s market recap provided by VPM Partners

Best Wishes,

Zeller Kern Investment Committee