I can’t project the future of the economy, nor do I pretend that I can. But there are some that do and they make it their profession. Some of these are economists, some of them are Fed governors. And I freely concede that projecting the economy is probably an imprecise science as it is highly complex and subject to unexpected influences. But I must confess I know of no profession where one can be off by over 50% or more on a regular basis and still be given credibility of any sort.
The latest example came with Friday’s dismal NFP report:
The sputtering U.S. economy created just 126,000 jobs in March as bad weather, weak consumer spending and flailing corporate profits resulted in the worst report since December 2013. Economists expected nonfarm payrolls to rise 245,000 in March.
Now one could of course dismiss this report as a one off bad report. They can and do happen. But context matters. After all, economists had also projected positive retail sales 3 months in a row yet they came in negative for each of these months. One would think that this context may indeed raise some alarm bells.
But we seem to live in an age where in the popular narrative all positive news items are evidence of a strong, fundamentally sound economy, and all bad news are dismissed as just temporary blips and anyone raising cautionary red flags is just a negative nelly. No bad news is ever the sign of something more problematic brewing.
But it’s not just one bad NFP number. It’s a fundamental view of the economy. Take this sample GDP timeline in 5 short weeks from one of the most bullish economists out there:
So we went from Q1 “liftoff” 3.1% to 1.7% in just 5 weeks. But even that 1.7% GDP projection on March 30 seems rather optimistic as the Fed’s Atlanta branch is already down to a 0.1% growth projection:
In its most recently estimate, the Federal Reserve’s Atlanta branch is projecting the U.S. economy to show just a 0.1 percent growth rate in the first quarter. At the same time, corporate profits are expected to drop about 3 percent for the period and another 2 percent or so in the second quarter, according to S&P Capital IQ.
The fact is Q1 GDP projections went from 3% to 0.1% in a mere 6 weeks and corporate profit projections plummeted just the same. These are not trivial little adjustments.
Now you can dismiss all this as “transitory” or “temporary” but one must recognize that the hurdle for meeting earnings growth to justify high P/E ratios has increased considerably:
Guess what happens when earnings drop? P/Es rise instantly. $SPX now over 20. So far prices haven’t adjusted. Yet. pic.twitter.com/KNxv5NoZP7
— Northy (@NorthmanTrader) April 3, 2015
However while all bad news may indeed be temporary, the charts suggest the unthinkable: That actually some sizable downside risk exists. And the unthinkable may be reflective of something more than “transitory” at play.
Here then is the message of the charts:
First off please note that these charts do not yet reflect the rather sudden drop in futures following Friday’s NFP report:
But here’s what they do show exclusive of the price data above:
$SPX held the 100MA, but closed below other key MAs:
The $DJIA closed below the 100MA and all key basic MAs:
In context the $SPX failed to recapture a key trend line:
Note in the chart above that while we’ve had several small pullbacks of note in 2015, we haven’t had a real flush yet. No move of the RSI line toward 30 or below so far. This has been a frustrating element for swing traders who haven’t yet found a spot of relative confidence where to enter a long position. Personally, I suspect, this has kept plenty of traders on the sidelines.
Given the Friday futures reaction to the #NFP report we may well see a break of support in the days ahead. Support has been stubborn in the 2040 $SPX area for months now. It is obviously a key area for the market and should it break it’ll likely produce some solid energy to the downside. In the $SPX chart above we see several key trend & support lines as well as larger moving averages that suggest tradable bounces are to be had on a break of support.
How persistent has this support been? One look at the monthly $TRAN chart with lower highs makes this abundantly clear:
So how much downside risk does exist? Over the past couple of weeks Mella has already outlined a notable structure and when the bull chick is cautious I really do pay attention:
$SPX – look i can spell pic.twitter.com/55uNR3SSgz
— Mella (@Mella_TA) April 1, 2015
What makes Friday’s futures drop so potentially precarious? Note where the $BPSPX closed the week:
This comes in context of the monthly double top in the $OEX we’ve been discussing last month:
No, this market is very much on the cusp and it is precisely the monthly charts that are highlighting the potential for a larger flush to the downside. For months we have been pointing toward a weakening in the monthly MACD. While the crossover was averted several times, this same exercise seems to be much more difficult to repeat now as we are seeing a clear break:
These monthly crossovers are indeed rare as a zoomed out version for a larger time frame makes perfectly clear:
And these crosses do have consequences. That is the historical record. Now we may well find ourselves in a 1998 type situation where such a cross is to be found “temporary” before new highs are reached. But even a temporary cross back then produced a move toward the monthly middle Bollinger band. If it’s not a temporary cross then a move toward the lower monthly Bollinger band could be in the offing. That gives one a debatable and potential risk range of 1700-1932 on the $SPX. That is, if the larger bull market trend doesn’t change for the worse.
The weekly $SPX chart we’ve been following continues to support tests of at least the 50MA and even possible the 100MA which gives a risk range of 1872-1998:
Again here the year 1998 example suggests the potential for a temporary correction for a buyable swing low to end in new highs. It is not until these key MAs are crossing over each other that the prospect of a real bear market is in the offing.
And let’s be perfectly clear: We are very far from any of this. But what these charts highlight is downside risk rooted in historic precedence. Yet risk and actual price action are not necessarily the same thing. But investors have been spoiled by a complete lack of serious corrections in years. These periods do happen, but they also tend to come to a sudden halt with sudden and fast corrective action:
How to trade all this? We’ve been focusing on both the short and long side based on the emerging technical picture. We’ve talked about some of this process in recent articles:
Surfing the $SPY
This week we switched long for a bounce and flipped short again on hitting the trend line target. From the member feed:
Support has not broken yet as of Friday’s futures close so we can’t know if the targets will get hit, but so far so good:
From our perspective this first real flush of 2015, whenever it happens, should provide for a tradable swing long play. At least for a bit. The potential proximate cause:
1. The largest source of stock purchases in Q1, buybacks, will be a factor again as soon as earnings are announced.
2. Earnings estimates have been taken down aggressively. The game: Take estimates down lower than they will be, then beat lowered expectations = Rally.
And as long as the Q1 downturn is indeed just “temporary” and “transitory” then bulls should be fine. But if not, then the unthinkable may indeed happen. But we can’t know, nor pretend to know.
But we can stay flexible in both directions and take advantage of the emerging volatility while being keenly aware of downside risk and view all the positive projections with some healthy skepticism. After all, as of today every forecast by economists, analysts and the Fed about earnings, GDP and retail sales in the current quarter have been completely wrong.
Last year the $SPX P/E was 17.69, now it is 20.25. With negative earnings growth is a move back to 17.69 really so unreasonable? That’s a 13% adjustment to the downside.
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