Market Analysis

Weekend Charts: Shock to the System

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.

January 23 turned out to be an interesting day.

On the one hand we had sentiment as expressed by the ultimate FOMO call:

Ray Dalio January 23: “We are in this Goldilocks period right now. Inflation isn’t a problem. Growth is good, everything is pretty good with a big jolt of stimulation coming from changes in tax laws…we will see “a market blowoff” rally, fueled by cash from banks, corporations and investors.”There is a lot of cash on the sidelines. … We’re going to be inundated with cash,” he said. “If you’re holding cash, you’re going to feel pretty stupid.”

On the other hand we had technical danger signs all over the place including this one from yours truly:

2018 Corrective Risk Zones January 23: “$SPX has not touched its daily 200MA since the US election in November 2016. Currently it sits 13% above it and puts it squarely in the historic danger zone as discussed in Stretched. Reminder: At its peak in 2000 $SPX was 13.6% above its 200MA before it all fell apart”.

Only 2 weeks later we got the reconnect:

Yea, I’m sticking with technicals thank you very much. For weeks I’ve been pointing out how technically these markets have been acting and they continue to do so beautifully and hence that’s our continued focus.

Friday night we also got the obligatory bounce off of that 200MA:

I say obligatory not only because markets continue to react at MA pivots, but also because the bounce was well advertised in advance with key signal charts.

One of which I shared on Friday before the open:

The historical context:

The bounce also made sense in context of the technical trend of the past 2 years:

$SPX bounced right off of the trend line. Did I mention this market is acting very technically? 🙂

So the location and timing of the bounce was no surprise, whether it will drive a more meaningful low remains to be seen.

What should be absolutely clear to everyone by now is that this correction is not like any we have seen in a long time.

Why? Because $VIX refuses to die:

Rid of its executed nemesis, the $XIV, the $VIX has been free to return to its historical range and to its highest weekly close since 2011.

Make no mistake: This was a shock to the recent market structure:

From my perch the synchronized intersection of 30 year old trend lines in both the stock and bond markets laid the foundation for this shock. It all coincided at the same time:

The breakout of $SPX above its 1987 trend line, the breakout of the 10 year above its 30 year trend line and volatility exploding as a result of the rejection of stocks above the trend line:

And it all came together on the heels of excess, technical disconnects and record optimism and retail inflows as unemployment has reached a cyclical low which is usually precisely the time when optimism peaks.

I have to admit: I find this chart above absolutely fascinating, especially when viewed in context of the most recent bubbles as both the 2000 and 2007 bull markets ended when the 10 year tagged its trend line. But the $SPX trend line may be more disturbing in its own right. It suggests that the trend line broke in 2008 and has never recovered. And that QE, low rates, tax cuts and any other artificial stimulus method failed to fix the broken trend line. To be fair it gave it a good effort to break above it January, but it failed miserably.

You and I may only see what happens day to day and week to week, but there are enormous structural forces at play and they take years to play out and this chart suggests we have reached a pivotal moment in history.

The relationship between stocks and bonds is now front and center:

“U.S. stock investors have now turned hypersensitive to rising yields after the past week’s surge, which lifts borrowing costs and could curb economic earnings and growth, Yardeni said. That also comes against the backdrop of accumulating government debt.

Jeffrey Gundlach, known as Wall Street’s Bond King, told Reuters it is ”hard to love 10-year Treasury notes even at a 3 percent yield with boatloads of bond supply and a 4 percent real GDPNow and 2.9 percent average hourly earnings.

“Plus, if the economy tanks from the stock market crashing, then you are looking at even more supply. Like a couple trillion more on top of the couple trillion already barreling toward us in fiscal 2019,” Gundlach said.”

And this all goes to the core of the Ultimate Bear Chart I recently discussed. Despite the market bounce on Friday the ratio closed below the 2012 and 2013 highs:

That’s a technical concern. It’s still above the neckline I discussed in the original article, but the technical relationship is now well established.

If you think record low unemployment and supposed expanding growth and a Republican led Congress (think fiscal conservatives) would lead to lower deficits you are mistaken. Quite the opposite is unfolding in front of our eyes, and if you have followed me on twitter for a while you knew this was coming:

Increased borrowing costs, exploding debt, rising deficits, all pre-recession. You do the math.

There are big wheels turning here and I suggest everybody pay real close attention. Things have changed. Stocks may have bounced on Friday, but they are not off the hook. Far from it. Despite heavily oversold readings on many charts 2 charts in particular suggest there maybe further risk to the downside:

$NYSI is not oversold yet:

And RYDEX allocations still show predominantly bullish allocations:

While we may see panic in sentiment we haven’t seen panic in portfolio allocations yet.

Bottomline: We’ve seen a long overdue technical reconnect from historic overbought readings. We’re oversold enough that we may see sizable bounces and attempts to calm volatility down. Rallies have been sold aggressively and bulls need to see this dynamic change. For as long as rallies are being sold lower risk targets remain:

On the latter chart a big red flag for the bull market: The recent highs came on such extreme overbought RSI readings that renewed highs (if they come) are virtually guaranteed to come on a lower RSI reading, meaning a negative divergence, the classic death blow to bull markets.

But new highs will not come easy to this changed market. Perhaps they won’t come at all. For now we can observe that MAs matter to this market. The 200MA has held twice on the $ES and the 50MA was perfect resistance on the bounce earlier in the week:

Should the current double bottom on the $ES hold there are plenty bounce targets above to consider including the fib zones, gaps and various MAs, including the 21MA.

While the action may be unsettling for recently deployed retail and hedge fund money, for technical traders this new widened price range is paradise offering plenty of opportunities to trade the action in both directions. It took a shock to the system to break this market from its volatility compression chains, but now that it’s free it gives us the opportunity to traverse the ranges.

What are your views? Feel free to discuss below in the comment section.

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14 replies »

  1. Humanity itself and society as we know it need repair and need reshaping. This is what it takes in order to focus on other things than greed and ego. Maybe. Technically speaking we are at the top, i dont want to even imagine where the bottom is… because even if we live the best times of the modern era, at the same time they are the most challenging and dangerous.
    Lets hope everyone will learn something out of what’s to come.

    • Sadly I don’t think we’ve learned too much from the financial crisis as structurally we’ve not implemented fundamental changes, but rather went down the easy money and increased debt route and are hoping for different results.

  2. If I had speculate I’d say the markets could see another 1987 style crash versa a 1929 depression as I do think the new tax cuts will help the economy in the coming years but a flush out in the market is much needed first before long term growth (real) can happen.

  3. Uncertainty is reaching new levels, when even an astute and correct bear says he’s no longer bull or bear. It’s the inverse equivalent of elevator operators confidently giving Henry Ford stock tips. In uncertainty like this, cash will become the only sure thing because you can’t buy food or pay rent with stocks, bonds, or gold. The roller coaster may make a strong attempt at a few more big hills, but the big top is in, and after a few lower highs, that will be apparent to the herd. It may start with a staggering crash, and then play out like an expanded rhyme of 1929 to 1935.


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