Markets Overbought; Geopolitical Tension Threatens

Last week provided random surprises and a dearth of economic data.  Congressional House leadership is gearing up for what will likely result in a new House Majority Leader later this week and geopolitical tensions are back on the rise.  Also making headlines, the European Central Bank announced a series of stimulus measures last Thursday sending U.S. markets higher on the news.  Those policies, which include a negative 0.25% interest rate on banks for their deposits, will continue to provide important insights for traders.  The ECB began implementing some of their plans last week; time will ultimately tell whether this tactic will yield positive results.  Despite the unexpected, the market narrative remains positive and last week’s softness seems warranted following several weeks of gains.  But the bigger question among investors is who will win the battle between bonds and stocks?

When stocks and bonds become strongly correlated, things get interesting.  Basically, we are experiencing a tug-of-war between the two asset classes.  When markets reach junctures such as this, we focus on technical indicators to gage the validity of market trends. Over the last few months, our intermediate-term indicators (50-day moving averages) have been oscillating in a tight range without any decisiveness; up or down.  However, since the bullishness regained its footing in late May, readings are now setting themselves apart.  We think it’s acceptable, and positive, for stocks to burn off recent gains.  In other words, overbought conditions are becoming more normalized, for now.  This doesn’t mean we will avoid some consolidation but it does suggest internal strength in the market.  Encouragingly, small cap stocks are continuing their recovery.  As long as the market maintains this breakout, and small-caps work higher, we feel longer term prices have some room to move higher.

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