The bulls are back. $SPX up nearly 8% in January and nearly 14% off of the December lows. What slowing global growth? What reduced earnings expectations? Trade wars? Who cares. It’ll all sort itself out, all that matters was the Fed caving in spectacular fashion laying the foundation for the big bull case. The central bank 2 step is back: Dovish + dovish = nothing but higher prices. The lows are in, what else can I buy? This pretty much sums up current sentiment.
And so goes the familiar script during emerging bear markets, a general sense of relief that the lows are in and a return of optimism and greed after an aggressive counter rally following an initial scary drop. Long forgotten are the December lows after a torrent consecutive 6 weeks of higher prices.
While indeed a renewed fully dovish Fed may be all that’s needed to keep 2019 bullish (after all this playbook has worked for the past 10 years) there is evidence that this rally may turn out to be a big fat bull trap.
And it’s not a single data point, but rather it’s a confluent set of factors that are acting in concert that give credence to this possibility.
Let me walk you through the factors step by step.
Firstly here’s the big monthly chart of everything as I call it which includes $SPX, some basic technical elements, but also a price chart of the 10 year yield ($TNX) and the unemployment rate:
Note the common and concurrent elements of the previous two big market tops (2000 & 2007) versus now:
New market highs tagging the upper monthly Bollinger band on a monthly negative RSI (relative strength) divergence – check
A steep correction off the highs that breaks a multi-year trend line – check
A turning of the monthly MACD toward south and the histogram to negative – check
A correction that transverses all the way from the upper monthly Bollinger band to the lower monthly Bollinger band before bouncing – check
A counter rally that moves all the way from the lower Bollinger Band to the middle Bollinger band, the 20MA – check
A counter rally that produces a bump in the RSI around the middle zone alleviating oversold conditions – check
All these events occurring following an extended trend of lower unemployment, signaling the coming end of a business cycle – check
All these events coinciding with a reversal in yields – check
All these events coinciding with a Federal Reserve suddenly halting its rate hike cycle – check
I submit that the current counter rally is consistent with all of these factors. Indeed, as with counter rallies in the past, this rally remains below its broken trend line.
What can we learn from the counter rallies during the two previous emerging bear markets?
In 2008, following the 2007 top, $SPX fell deep below its 200MA, but then saw an aggressive counter rally in a rising wedge pattern that stopped at the 200MA before everything reversed:
What did optimistic, the coast is clear, buyers know then? Nothing as $SPX didn’t bottom until 666 in March 2009.
In 2001 $SPX rallied hard from a yearly low in December (similar to now) and the high was made on January 31, the last trading day of the month. Unbeknownst to buyers then that day turned out to be the high for YEARS to come as markets turned south in advance of the coming recession:
Lows didn’t come until 2002/2003.
Look, my eyes are wide open here, I recognize that between the dovish Fed and a potential China deal markets may just drift higher and any pullbacks could turn into buying opportunities.
However, as long as $SPX remains below its 200MA without a confirmed breakout above the confluent set of elements discussed above suggest there is well founded risk that this market can still turn into a full fledged bear market. After all growth is slowing, earnings growth is slowing and the last 3 times the Fed halted its rate hike cycle a recession soon followed.
And what do we have so far? An aggressive counter rally below the 200MA in a very steep ascension pattern approaching key .618 fib resistance:
In early 2018 the 200MA was support, in the fall it became resistance. $SPX remains below it and I think it’s fair to say we’re no longer oversold. Indeed a dovish Fed has now been priced in. Jay Powell made sure of that on January 4th and confirmed it this week. That carrot is gone.
While the bull case remains technically unconfirmed at this stage the bull trap scenario will also remain unconfirmed for some time. The first few down days following the peak in January 2001 and the peak in May 2008 did not have anyone waving a big white flag screaming the top is in. It’s easy to see these things in hindsight, but much harder, if not impossible, if you’re in the thick of things. And this is where we are now, in the thick of things, and will be for weeks to come, but I suspect we’ll know more in the next month or two. Stay sharp.
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