Statistical Analysis Tells Us a Nasdaq Boom Predicts a Broad Market Boom. Trade War, China is Nervous…That is Smart. Sentiment Highly Bullish.

Yesterday we highlighted the fact that the Russell 2000 has reached an overbought level that has occurred just twice in the last 2 years. Right on cue, the R2K sold off sharply, down 1.18%, leading the rest of the market lower (along with its co-leader, the Nasdaq).

But again, I see no serious signs of an impending and larger sell-off here. In fact, new 52 week highs to lows were positive 313–281, something that we simply do not see in a market that is dramatically weakening. Yesterdays 196 point drop in the Dow Jones has taken it back to highly oversold levels, now just 220 points above its 200 dma. Obviously, we want to see this level hold. Here’s why I am highly confident that it will…

The leader, following the 2/9 lows, has indisputably been the Russell 2000. US small cap stocks are (mostly) immune from concerns of a trade war, as 90%+ of their business is done inside US borders.

I point the IWM (small cap ETF) out to you this morning for the following reason; small caps have only been this overbought twice in the last 2 years. What followed, in both cases, was either a pause or a something larger (12% drop following the January highs).

According to the VRA System…and my 33 years of doing this…now is not the time to be adding to positions in this sector. While we do have exposure to this group, our positions are more in the “small cap, story stock” category and should be immune from any pullback in the small caps.

If you’re a fan of statistical analysis (I am), and remain bullish (as I am) you’ll find this interesting (with thanks to BullMarketsCo):

When the Nasdaq is as strong as its been over the last 4 months, outperforming the Dow Jones by more than 12%, the end result is a highly bullish broad market move higher over the course of the next year, with the median 1 year move higher in the S&P 500 of 16.68%. The median move higher in the S&P 500 over the following 6 months is an even more impressive 12.44%.

This supports my research of more than 3 decades, which we’ve covered here often; when the Nasdaq leads the way higher, the broad markets are almost certain to follow. It’s the ultimate “a rising tide lifts all boats” analogy.

Big troubles in China

China, as of yesterdays close, both mainland Chinese stocks and Hong Kong traded Chinese stocks, have hit their most oversold levels in 2.5 years. I continue to expect China to cave on trade with the US/Trump. Because, if they do not, their already 40% collapse in the Shanghai Stock Exchange will turn into something much worse. The Chinese economy is slowing…of this there can be no debate…and with debt/GDP already at 250%+, a prolonged slowdown could result in a form of a death spiral in Chinese debt. Yes, they are most aware of this. And no, I do not expect this to take place. But Trumps not kidding around here…trust me when I tell you that China is increasingly nervous.

The following 3 tweets from this week give you an idea of my thoughts about the potential for a trade war with China. Bottom line; a trade war will only take place if China is suicidal.

Again, when you have debt/GDP of more than 250% (almost equaling Japan), and with a state sponsored semi-capitalist system that is causing serious havoc in the form of rapidly rising corporate defaults, this is NOT the environment from which you want to enter a trading war with your most important import partner (the US, of course).

Trump knows all of this. His team, led by very sharp and hard edged negotiators Wilbur Ross and Peter Navarro, knows all of this. China, were they to repeat the mistakes of 80’s/90’s Japan, would be forced to issue obscene amounts of debt just to survive total economic collapse. History tells us that totalitarian nations do not weather economic collapses all that well (Germany, Russia, Italy, etc).

China has already lost this battle with Trump. The only thing missing is some form of face-saving admission. Look for that in the near future.

Final point; late last night the White House released this 35 page document on trade with China, along with how China has stolen (at minimum) $10 trillion from the US in just the last 20 years. Must read for those that want to understand Trumps views on trade. Take your blood pressure medication before reading it…

https://www.whitehouse.gov/wp-content/uploads/2018/06/FINAL-China-Technology-Report-6.18.18-PDF.pdf

Investor Sentiment

Below is the weekly AAII Investor Sentiment Survey. I’ve used this exact sentiment survey since the late 80’s and today, it’s not even close to indicating that a market top is on the horizon. Not. Even. Close.

Bulls sit at 38.7% (down 6% on the week), with bears at 26.2% and neutral investors still at a very big 35.1%. Remember, at the January highs bulls were 60%. Remarkably (to me), even with the nasdaq and R2K hitting all time highs daily, investors continue to be skittish. As contrarians, this tells us that stock prices have a long, long ways to go before investors are complacent…much less euphoric.

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Until next time, thanks for reading…

Kip