Shocking revelation: US stocks are in an uptrend!

Far from being "breaking news", the consistently strong performance of the major US (and international) equity indices is taken for granted by everyone from the richest hedge fund manager to my retired grandmother. When everything is going swimmingly on the surface, one way to gain an edge is to look "under the hood" at the factors driving stocks and the market internals.

Starting with the early results from Q4 earnings season, there is little cause for concern yet. While a huge one-time write-off from megabank Citigroup is denting the aggregate numbers so far, it's worth noting that 68% of the S&P 500 companies that had reported as of Monday had beat earnings estimates, roughly in-line with the 5-year average (69%). Critically, analysts expect aggregate earnings for 2018 to rise by a stellar 18.6% year-over-year on revenue growth of 6.0%. Of course, these estimates could eventually prove to be too rosy, but for now, the engine that powers stock prices is accelerating.

Turning our attention to the market internals, the technical outlook is just as bullish under the surface. Let's start with market "breadth", which simply seeks to quantify the number of stocks showing bullish and bearish characteristics. In general, breadth can provide a leading indicator for the indices. If an index is rising but showing deteriorating breadth, it suggests that the rally is being driven by just a few -- likely large-cap or highly priced -- stocks, which generally means it is more vulnerable to a downturn. Conversely, a falling market with improving breadth is often a precursor to a significant bottom, as it shows that the "market of stocks" is improving.

As the chart below shows, the advance-decline lines for small-, mid-, and large-cap stocks are all breaking out to new highs, confirming the strength in the overall indices. Far from being driven by just a few "story" stocks, the ongoing rally is seeing broad support from the vast majority of the publicly-traded companies across the board.

Source: Faraday Research, Stockcharts.com

Another aspect of the market internals is sector rotation. For the uninitiated, sector rotation is the subset of technical analysis that involves evaluating what types of stocks are performing well to help predict how the stock market as a whole will perform moving forward. Historically, economically-sensitive sectors technology, material, and energy stocks tend to outperform the stock market in a healthy uptrend, while economically-insensitive sectors like utilities and health care stocks typically outperform when the market is at risk of a pullback.

From a sector perspective, the price action over the last three months suggests that we're solidly in the middle of a healthy bull trend. Classic economically-sensitive sectors like consumer cyclicals, energy, and technology stocks have been leading the way, each rising more than 13% over the last three months. Meanwhile, more defensive stocks from the consumer staple, health care, and utility sectors have been among the worst performers.

Source: Faraday Research, Stockcharts.com

If, and it's a big "if", this market trend follows the textbook sector rotation cycle, inflation-sensitive sectors like energy and materials could soon rotate into a leadership position. That price action, if seen, would suggest we're approaching the proverbial "7th or 8th inning" of the bullish trend. Any shift in favor of classic defensive groups like consumer staples, healthcare, or utility stocks would be a big warning sign to bulls.

For now though, the "under the surface" facets of the market's bullish trend are confirming the underlying strength. We see no signs of an imminent top yet, though elevated long-term valuations and stretched short-term prices could certainly lead to near-term dip or consolidation.