Market Analysis

Weekend Charts: February 4

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Introduction: Consider Weekend Charts as an ongoing follow-up to my 2018 Market Outlook. I’ll be sharing high level technical observations on a weekly basis whenever possible. For other public analysis please see the latest posts on NorthmanTrader. For our market services, including technical setups, please visit Services.

The only surprising aspect about last week’s market drubbing was that it took so long. From a historic perspective the pullback was way overdue as the beginning of 2018 was marked by a relentless one way push into equities driven largely by record retail inflow into equities as optimism reigned supreme and 2018 earnings estimates were being raised on the heels of the recent tax cuts.

Retail went full FOMO….

…as former bears capitulated and in some cases fermented an atmosphere of participation angst:

Bears are dumb. Don’t you know:

Well done:

In essence we witnessed part of the script I outlined in my 2017 Market Lessons:

“The biggest mistake bears always make, myself included, is underestimate the sheer recklessness of bulls. They keep raising the bar higher and higher, get everyone positioned long and when the construct ultimately fails they beg for bailouts and artificial liquidity comes in to save an industry that is 100% reliant on convincing retail to put money into the system. This may seem a harsh assessment, but this has been the script for the last 30 years as we’ve transitioned from one market bubble to the next.

Bubbles are notorious for getting people sucked into believing things that are absolutely unrealistic. Multiples get expanded to high heaven on projections that never pan out. Every. single. time.

It’s a dangerous game for investors as Wall Street will look right for years and complacency breeds more complacency as bearish voices are ignored as they look wrong precisely at the time when they are the most right”.

Now let me be perfectly clear: I’m not calling for a top in markets, nor do I call last week’s pullback a vindication of the bear thesis. Markets are still positive for the year and, if anything, last week’s pullback was simply a technical reaction from historic overbought conditions. The structural bear case will unfold in due time.

However the action also highlights the potential risks retail investors face having deployed record amounts of cash into one of the most expensive and technically uncorrected markets in decades.

Rather I want to emphasize this key point: Markets are acting very technically and this provides traders with ample opportunities to partake in the volatility. One of the key lessons of 2017 after all was to separate macro structural analysis from trading of technical setups something we have been focusing on relentlessly.

For me the key messages of last week were that 2 way price discovery is back, volatility has returned with a vengeance & technicals are working. Big time.

Let’s dive into charts in context of the recent action.

Technically speaking the pullback was not surprising. In last week’s Weekend Charts I made this point:

“It is the chart of the $DJIA in particular that keeps highlighting technical danger signs:

I’ve shown the quarterly chart and the extreme has become more extreme with price not only totally outside its Bollinger band, but being 8% above its upper Bollinger band and nearly 13% above its quarterly 5EMA:

“There is no history to suggest this is sustainable. This price move remains the most extreme technical disconnect in the $DJIA ever.”

This week we got the technical reaction:

How technical is this market? Very. Technical patterns are working precisely and we’ve shown some of these publicly. I’ve talked about Volatility Rising and Mella even posted a specific 17 target on the $VIX when it was still at 11.68 on January 24:

And on Friday the target was reached:

As a technician I love the beauty of technical patterns, especially when they work out precisely. The $NDX this week gave such an opportunity and I’m showing this example to highlight the predictive power and relevance of technical SetUps:

As you can see on the twitter thread I kept documenting the progress of the pattern throughout as the action unfolded and price reached the pattern target:

And precisely at target we also saw the initial counter reaction:

So yes, I’m pleased to see the technical action as it keeps informing technical SetUps and risk/reward opportunities.

In this context even Friday’s close made perfect technical sense as it stopped precisely at the .382 fib off of the November lows:

So what’s next here?

Last week I highlighted one the of signal charts suggesting trouble in the rally:

“Take a signal chart such as $NYMO. Stocks flew to new all time highs again, yet $NYMO closed negative”:

“This suggests troubles in internals underneath”.

As informative as the chart was last week it may also give us a clue as to the severity and extent of last week’s drubbing. Indeed the chart reached its most oversold reading since the 2016 lows::

But not only did $NYMO reach an extreme reading on the daily chart it also showed its lowest weekly close since 2014:

This suggests that a sizable bounce is in the offing either from lower levels or fairly immediately.

It is what happens after this bounce that will more relevantly define the further direction of this market in 2018. Keep in mind that, while last week’s corrective move was the most extensive one since the US election, it is still historically small.

I’ll leave you with 3 charts to consider:

Retail is still fully bullish allocated:

$VIX has broken breaking out of its multi year descending wedge pattern:

And global stocks retreated precisely from the same monthly extreme RSI readings we saw in 2007 as volatility is breaking out:

Concluding: Already 2018 is proving to be a different market than 2017. Volatility and 2 way price discovery have returned and technical patterns and signals are working and provide flexible traders with ample opportunity to partake in the action.

Related reading:

2018 Corrective Risk Zones

The Ultimate Bear Chart

For the latest public analysis please visit NorthmanTrader. For our market products please visit Services.

All content is provided as information only and should not be taken as investment or trading advice. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. For further details please refer to the disclaimer.

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