Stuck In The Middle (Range) With You

On Tuesday, I asked the question as to whether the “bull is back” or “is it a bull trap?” This question was triggered by the outsized advance on Monday on hopes the “trade war” had been at least temporarily resolved at the G-20 summit:

“The good news is that on Monday the market cleared the 50- and 200-day moving averages. This was an important level of overhead resistance the market needed to clear to get back onto more bullish footing. However, in order for that break to be validated, it must hold through the end of the trading week.”

Unfortunately, the bulls quickly lost that foothold on Tuesday as the markets tumbled wiping out not only all of Trump’s “trade truce” gain, but “Powell’s Put” gain as well. Then on Thursday, news the CFO of Huawei had been arrested sent shock waves through the market which sent the Dow plunging nearly 800 points. The only saving grace was when a Fed official was trotted out to suggest the Fed was likely going to pause rate hikes. But, on Friday, weaker employment, confidence, and wage growth numbers sent the markets back to their lows once again.

Also, while it is has been widely suggested to dismiss the negative crossover of the 50- and 200-dma moving averages (red circle), what it represents is mounting downward pressure on stock prices currently.

However, for all of the volatility, the market has not made any real progress since October as the “bulls” and “bears”continue to fight it out in a broad trading range as shown below. While the lower support is currently holding at 2632ish, a failure of the that low will quickly lead to a retest of lows from March and April of this year.

So far, the consolidation of the market has continued to give supports to bulls case as sentiment has gotten very negative during this time. However, as I noted on Tuesday for our RIA PRO subscribers:

“Most importantly, the most recent failure at key resistance levels has set the market up to complete the formation of a ‘head and shoulder’ process. This is a topping pattern that would suggest substantially lower asset prices going into 2019 ‘IF,’ and this is a key point, ‘IF’ it completes by breaking the lower ‘neckline.’” 

Chart updated through Friday

John Murphy via Stockcharts.com confirmed the risk to prices as well on Friday:

“S&P 500 MAY HAVE MORE DOWNSIDE TO COME …

The daily bars in the chart shows the S&P 500 retesting previous lows formed in late October and late November. And it’s trying to hold there. The shape of the pattern over the past two months, however, isn’t very encouraging. Not only is the SPX trading well below its 200-day average. The two red trendlines containing that recent sideways pattern have the look of a triangular formation (marked by two converging trendlines). Triangles are usually continuation patterns. If that interpretation is correct, technical odds favor recent lows being broken.

If that happens, that would set up a more significant test of the lows formed earlier in the year. Other analysts on this site (besides myself) have also been writing about that possibility. That would lead to a major test of the viability of the market’s long-term uptrend.”

Also, note that the lower MACD is close to registering a “sell signal” which would likely coincide with further weakness in asset prices.

Is there any hope a bigger decline can be averted? Absolutely.

The recent market turmoil, which threatens both consumer confidence and the household wealth effect, has shaken the Fed from their “hawkish” position. In the next few days, the market will be analyzing Jerome Powell’s latest message as the Fed hikes rates 0.25% in December. If the language of the announcement becomes substantially more “dovish,” and signals no more hikes into 2019, the markets will initially rally sharply on the news. However, given that a Fed pause at 2.5% would signal much slower economic growth, it will likely only be a temporary boost until weaker earnings are realized from slower economic growth.

The other potential opportunity is for the current Administration to drop the “trade war” rhetoric. Given that Trump created the “trade problem” to begin with, even small gestures of trade improvement between the U.S. and China would be counted as a “Trumpian victory.” However, a reversal or reduction of the tariffs would be a boost to corporate earnings and provide a boost of confidence to corporations.

Again, as with the Fed funds rates, the reduction of tariffs would most likely only provide a short-term boost to asset prices. Eventually, the focus of the markets will turn back to earnings and economic growth which are going to slow as previous boosts from natural disasters and tax cuts fade. 

However, that is in the future.

For now, we have to deal with what “IS,” and the weakness of the market is very concerning.

After having reduced equity risk a couple of weeks ago, we are looking for opportunities as they present themselves. However, for the most part, our bond positions have continued to carry the bulk of the load as of late as rates continue to drop.

As I noted on Friday, don’t dismiss the yield curve too quickly. But like our technical indicators below, we are looking for confirmation of several curves to go negative simultaneously which has historically provided the clearest signal of a recessionary onset.

Daily View

Weekly View

On a weekly basis, the story remains much the same. With a sell signal registered for only the 7th time in the past two decades, we will just allow the markets to figure out what they want to do before getting more aggressive. The recent violations of long-term moving averages suggest a change in market conditions that should not be dismissed. However, should the market improve, and ultimately reverse the relative “sell signals,” we will gladly increase exposure back to target weights.

Action: Hold higher levels of cash and rebalance risk as necessary on this rally.

Monthly View

Like the daily and weekly analysis above, the market has confirmed a “sell signal” on a monthly basis as well. The good news here is that the long-term moving average, which is a critical level of bullish trend support, has NOT been violated as of yet. This suggests the longer-term bullish trend remains intact and we should not get overly conservative just yet.

Nonetheless, the deterioration in the markets is extremely concerning, and while the official “bull market” is not dead as of yet, there are more than enough warnings which suggest erring to the side of caution, for now, is warranted.

Action: Use any rally to reduce risk and rebalance portfolios accordingly.